vertical+integration

Jason Strachman The information was acquired from //Managerial Economics and Business Strategy// by Michael R. Baye on page 207 and pages 217-218.


 * Vertical integration** occurs when a firm produces the inputs required to make its final product. Firms no longer have to rely on other firms to provide the desired inputs. However, choosing vertical integration has some disadvantages. Firms lose the gains in specialization it would realize if the inputs were purchased from a supplier. The firm now has to manage the production of the inputs in adddition to the final product. The company will likely need to acquire additional production space and more employees to produce the input. In addition, the larger a company is the more bureaucracy and over lap that often occurs which will lead to higher costs.

Companies decide vertical integration is the best approach when specialized investments generate high transactions costs and when input is too complex or the economic future of the input is uncertain that writing contracts are too costly and time consuming. When these factors exist companies determine that integrating vertically is the most cost effective decision because it skips the middle man.

If Dell Computers decided that it wanted to produce not only the final personal computer but also components like the computer chip, keyboard, and/or monitor, then Dell would decide to use vertical integration. The opposite would exist if Dell purchased these items from other manufacturers that specialize in it and Dell only concerned itself with producing the final personal computer unit. Automobile manufactures perform vertical integration when they make their own fenders out of steel. A company does not have to make all of the inputs to be vertically integrated but the level of vertical integration depends on how many of the inputs are made.

__Question 1:__ True or False -- vertical integration occurs when two companies make specialized investments to engage in exchange? __Question 2:__ Vertical integration is the situation where a firm produces what in addition to the final product? A. the production facility B. the relationship between two companies C. the inputs D. All of the above
 * Answer is False**
 * Answer is C**