HW 2 Answers:
3.
a. Contract.
b. Vertical Integration.
c. Spot exchange (or possibly contract if a specific investment in many motors is required).
d. Spot exchange.

4. Engine manufacturing involves specific investments and a complex contracting environment. By vertically integrating, the potential for opportunism is reduced. Mirrors are relatively uniform products that can be purchased by spot exchange or contract.

5.
a. Human capital.
b. Physical asset specificity; note that the assembly line was designed especially for a particular firm’s product.
c. Site specificity.

8.
a. Reduce the benefits of vertical integration.
b. Reduce the benefits of vertical integration and lead firms to use contracts or spot exchange to procure inputs.
c. Lead to contracts that are more detailed or vertical integration.
d. Make spot exchange an unattractive method of procurement due to opportunism and possibly underinvestment.
e. Make contracts a less attractive form of input acquisition.
f. Lead to longer contracts, or in extreme instances, vertical integration.

9.
a. When MC(L) = 30 + 4L, the optimal contract lengths sets this equal to the marginal benefit of $100, yielding L = 17.5.
b. When MC(L) = 40 + 5L , the optimal contract length sets this equal to the marginal benefit of $100, yielding L = 12.
c. When the marginal cost curve increases, the optimal contract length decreases. When the marginal cost curve decreases, the optimal contract length increases.

13. Capping pension fund managers’ compensations would reduce the executives’ incentives to maximize the value of the fund under their control, thereby reducing the overall return to the fund participants.

14. Contracts requiring large specialized investments are expected to be longer than contracts requiring relatively smaller