when relationship specific exchange occurs in complex contra

when relation-ship specific exchange occurs in complex contractual environments, the best way to purchase inputs is through-

a. spot markets

b. vertical integration

c. short term agency agreements

d. long-tern contracts

Please explain why you made the selection.

Solution

A relationship-specific exchange occurs when Specialized investments are important

Vertical integration is the best way to purchase inputs also we can not have longterm contracts when it is complex envoirenment

Vertical integration is the best approach when specialized investments generate high transaction costs and when inputs are too complex or the economic future of the input is so uncertain that writing a contract proves too costly and time consuming.

Vertical integration is favored when the benefits of mitigating opportunism problems by moving the transactions inside the firm, by reducing ex ante investment and ex post performance inefficiencies,are greater than other sources of static and dynamic inefficiency associated with resource allocation within bureaucratic organizations.

The strong incentives for vertical integration arise because the vertically integrated firm is able to satisfy high probability demand by itself, and pass on the low probability demand to some other firm”

Vertical integration represents an alternative governance structure to bilateral contracts for mediating the supply of a product that requires specific investments to support cost minimizing exchange. Rather than fiddling with contractual protections to mitigate the inherent conflicts of interest that may arise between independent buyers and sellers in the presence of specific investments, and dealing with other distortions and rigidities that such contracts may entail, the buyer may choose instead to integrate backward into the supply of the input at issue