specialized+investments

Jason Strachman

This information was acquired from //Managerial Economics and Business Strategy// by Michael R. Baye on pages 209-210.


 * Specialized investments** are expenditures that must be made to allow two parties to exchange but has little or no value in any alternative use. Some examples of specialized investments are site specificity (when the buyer and seller of an input locate their plants close to each other to engage in exchange), physical-asset specificity (when capital equipment is needed to produce an input designed to meet the needs of a particular buyer and cannot be adapted to produce the needs of other buyers), dedicated assets (investments mad by a firm that allow it to exchange with a particular buyer), and human capital (workers often must learn skills for a particular firm that are not transferable to other employers).

Specialized investments increase transaction costs because they lead to costly bargaining, underinvestment, and opportunism.
 * Costly bargaining is the process of negotiating pricing between a buyer and a seller of a special input. The parties may behave strategically to enchance their bargaining position. For example, the buyer may refuse to accept delivery to force the seller to accept a lower price. When both parties have made specialized investments they are locked into a relationship with each other. If one backs out of the relationship both are hurt.
 * Since specialized investments are only good for the relationship between two parties (there is no value in any alternative use) then the parties are likely to underinvest. For example, if company XYZ purchases a special machine to make parts for company ABC and the parts are no good to any other company other than ABC then company XYZ may underinvest in the machine or purchase an cheaper machine that produces lower quality parts because it knows that if company ABC ever backs out of the relationship then the machine is worthless.
 * After a company makes a specialized investment the other party involved in the exchange will likely try to be opportunistic and take advantage of the situation by raise prices of lowering quantity demands to better their position. The company that made the investment is held up and has little option othe than to accept the current state because the specialized investment is no good if the exchange does not take place.

__Question 1:__ Specialized investments increase transaction costs because they lead to costly bargaining, opportunism, and _____?

A. high inventory costs B. employee turnover C. underinvestment D. All of the above

__Question 2:__ Which are examples of specialized investments? A. site specificity B. Physical asset specificity C. dedicated assets D. human capital E. All of the above
 * Answer is C**
 * Answer is E**