1. Define quasi-rent. Describe a situation where quasi-rents are exist, but not appropriable. In such a situation, does the existence of quasi-rents provide an motivation for vertical integration? Explain.
Quasi-rent: Payment in excess of the amount needed to keep a resource into its current use.
Suppose I own a hollow-hulled ship. I presently rent it to a firm for $150,000/year for the purposes of carrying oil. Other firms are also willing to rent it for $150,000/year to carry oil, and because they are located right next door to the first firm, it is costless for me to change the firm to which I rent it. Suppose the ship is practically useless if it does not ship oil -- non-oil-hauling firms are willing only to pay $10,000/year. In this case, quasi-rents equal $140,000/year, but none of the quasi-rents are appropriable.
In this situation, there is no hold-up problem because there is no threat of appropriation. The existence of quasi-rents does not provide a motivation for vertical integration.
Note 1: If the quasi rents were appropriable (other oil haulers were only willing to pay $100,000, for example), then quasi-rents would indeed provide an incentive for vertical integration.
Note 2: Vertical integration in this case implies that the same firm that builds or provides the ship also operates the ship.
2. In class I briefly mentioned that Alchian
and Demsetz' analysis sheds some light on organizational issues faced by
One can consider chains of outlets as members of a team, each of whom has incentive to free ride on the efforts of other members. One can think of franchisors as specialized monitors. The right to terminate franchise agreements is analogous to the right to alter team membership. Many of the other decision rights noted above, especially the decision how close to monitor franchisees, can be interpreted as instruments designed to prevent free riding at the outlet level. (Outlets could choose to order shoddy inputs, discontinue certain menu items, not advertise much or well, etc.)
Applying Alchian and Demsetz, franchisors hold this set of rights to improve their ability to serve as specialized monitors.
3. Using efficiency wage theory, explain why the salary of a 60-year old executives might be higher than the salary of 45-year-old executives who are equally talented and knowledgeable and whose outside opportunities are exactly the same.
Does efficiency wage theory provide a coherent explanation for why compensation generally increases with age for salaried workers? Why or why not?
60-year olds are close to retirement than 45-year olds. "N" -- the number of periods to go in the relationship -- is lower. Therefore, in order to satisfy the executive's "no shirking constraint," one would have to pay the 60-year-old a wage such that the differential between it and his/her next best opportunity is larger.
By a similar logic, efficiency wage theory provides a coherent explanation for why compensation generally increases with age for salaried workers. One has to pay them more and more to satisfy their no shirking constraint.
This is not the only possible theory for the relationship between wages and age. But it is a theory that is consistent with the facts.
4. Firms use various types of trailers when hauling goods by truck. Two examples are "basic vans" and "grain bodies." Basic vans are used to haul general freight: goods which are packaged in boxes and which are not temperature-sensitive. (These are the familiar box-like trailers you see on the road.) Grain bodies are trailers which have no top, but have sides which are reinforced by layers of steel that can withstand large amounts of pressure from inside.
Hubbard (1998) finds that nationwide, about 35% of hauls which use basic vans are completed by private fleets -- circumstances where manufacturers, distributors, retailers, etc., hauls their own goods. The rest are completed by for-hire trucking firms. In contrast, 75% of hauls which use grain bodies are completed by private fleets; only 25% are completed by for-hire fleets.
This is quite consistent with Klein, Crawford, and Alchian. Grain bodies are more specific to users. Lower density of users implies that it is more costly to find and transport the trailer to alternative users than for basic vans. Under competitive contracting, this implies that appropriable quasi-rents would tend to be greater for grain bodies than for basic vans. Vertical integration would hence tend to be efficient relative to competitive contracting more frequently for hauls using grain bodies than for those using basic vans.
[I operate a trucking company. Someone phones me up. We agree on a price. I drive the tractor-trailer to your door. Once I do so, it is costly for me to find and serve other shippers -- the more distant the alternative shipper, the more costly it is. If the alternative shipper is right next door and you try to renegotiate the price, I simply serve the shipper next door. If the alternative shipper is halfway across the state, you may well be successful in your renegotiation. The hold-up problem appears in the latter case but not the former, because the proximity of the alternative user affects the extent to which quasi-rents are appropriable. Alternative users tend to be more nearby for trailers which can be used to haul many commodities.]
Further research indicates that 55% of hauls which use grain bodies in Iowa are completed by for-hire trucking firms, but 5% of hauls which use grain bodies in Oregon do.