Application of Managerial Economics
Managerial Economics
Course Assessment 1
Transaction Cost of Economics (TCE) theory is to explain a firm’s structure and TCE’s key features are the determinants of the level of vertical integration. The process that begins with the acquisition of raw materials and ends with the distribution and sale of finished goods and services is known as the vertical chain[i]. A central issue in business strategy is how to organize the vertical chain. TCE, which was first contended by Coase in 1937 and developed by Williamson in 1975, is useful of facilitating decision-making process on vertical boundaries and organize vertical chain from input to output.
Transaction costs are the costs of time spend on searching with potential exchange parties, suppliers, negotiating the terms of exchange or contracts and the costs of monitoring contracts. Organizations purpose is to reduce transaction costs. We can see TCE as a framework that, based on cost efficiency, allows us to make the decision of how to coordinate exchange: will we use the market or buy? Transaction cost theory determines whether efficient firms should produce in-house or outsource production and distribution. When the cost of internal co-ordination is lower than the cost of using markets, the firm will decide to vertically further in order to internalise the costs of co-ordination between the different stages of production. For example, a lighting company used a vendor to paint their products when the production volume was below 10,000 pieces per month. Later on, frequency becomes higher and production volume above 10,000 pieces per month. The existing supplier cannot attain economies of scale that an in-house unit could not attain. Coordination becomes difficult. There is no need to have “intermediate” arrangements. The factory decided to buy a painting line and realize vertical integration with cheaper costs. Management of the factory must have compared the cost of internal co-ordination, which includes the
Course Assessment 1
Transaction Cost of Economics (TCE) theory is to explain a firm’s structure and TCE’s key features are the determinants of the level of vertical integration. The process that begins with the acquisition of raw materials and ends with the distribution and sale of finished goods and services is known as the vertical chain[i]. A central issue in business strategy is how to organize the vertical chain. TCE, which was first contended by Coase in 1937 and developed by Williamson in 1975, is useful of facilitating decision-making process on vertical boundaries and organize vertical chain from input to output.
Transaction costs are the costs of time spend on searching with potential exchange parties, suppliers, negotiating the terms of exchange or contracts and the costs of monitoring contracts. Organizations purpose is to reduce transaction costs. We can see TCE as a framework that, based on cost efficiency, allows us to make the decision of how to coordinate exchange: will we use the market or buy? Transaction cost theory determines whether efficient firms should produce in-house or outsource production and distribution. When the cost of internal co-ordination is lower than the cost of using markets, the firm will decide to vertically further in order to internalise the costs of co-ordination between the different stages of production. For example, a lighting company used a vendor to paint their products when the production volume was below 10,000 pieces per month. Later on, frequency becomes higher and production volume above 10,000 pieces per month. The existing supplier cannot attain economies of scale that an in-house unit could not attain. Coordination becomes difficult. There is no need to have “intermediate” arrangements. The factory decided to buy a painting line and realize vertical integration with cheaper costs. Management of the factory must have compared the cost of internal co-ordination, which includes the