Optimal Input Procurement and Transaction Costs in Business

MANAGING INPUTS

Optimal production process: Right mix of input+Efficient procurement +Optimal usage = Firm operates on the cost function and not above it.

Transaction costs => Excess costs on the actual amount paid to the input supplier. Play a crucial role in determining optimal input procurement.

Include: Costs of searching for a supplier, Costs of negotiating, Other expenditures

Transaction costs à General in nature – Eg. Transportation costs

Specialized investment – an investment that cannot be recovered in another trading relationship.

Specialized investments increase transactions costs because they lead to: Costly bargaining, Underinvestment, Opportunism

Spending on machine to test some device.

Types of specialized investments: 1. Site specificity, Physical asset specificity, 3. Dedicated assets, 4. Human capital

Methods of procuring inputs: 1. Spot exchange, 2. Contract with input suppliers, 3. Vertical integration.

Principal-agent problem à Offer a manager a compensation to receive 10% of profits

The manager-worker principal problem –> Profit sharing (Employee Stock Options, Revenue sharing)

GAME THEORY

Dominant strategy – best strategy for me no matter what others are doing

Secure strategy – I choose the best option from the worst option

Nash equilibrium – when we choose the best outcome in the context of what other players are doing. We look at the game from our rival's perspective.

No one can improve their position if only he makes strategy without looking on the rival.

Application on one-shot game: Only one time is playing. Nash equilibrium: lower price, because there is no deal. Best would be high prices, but we are afraid what other will put as a price.

Advertising – the game is playing as one-shoot game, it would be better if I advertise, because If don't advertise and other advertise, I will lose.

Coordination game – We have some standard that we choose. Nash equilibrium would be where we choose both together the same. Coordination can ensure higher profits.

Monitoring employees – managers want from their workers to work hard, workers enjoy leisure.

-Manager monitors while worker work – manager loses, worker wins

-Manager does not monitor, worker shirks, manager loses, worker wins

-Manager monitors, worker shirks – manager wins, worker loses

-Worker works, manager does not monitor – worker loses, manager wins

Infinitely repeated games – Firms CAN collude.

PV= 10+10/(1+i) + 10/(1+i)2

If interest rates are below 25%, the price of 10$ is good and we can stick to the deal.

Factors affecting collusion in pricing games: Number of firms, Firm size (the bigger the firms the less the costs of supervision), History of the market, Punishment mechanisms

Finitely repeated games – Games in which players know when they will end.

Repeated games with a known final period: the end-of-period problem

-Manager solution: Fire the worker as soon he/she announces the plan to quit

Multistage game – sequential game. If someone threats, war with prices.. threat not credible