Deck 14: Vertical Relationships

Question 1

_____, uncertainty, and risk of opportunism are the three major reasons due to which U.S.Steel prefers to own its mines, enrichment facilities, and ore carriers.

A)Involuntary transactions
B)Transaction costs
C)Nonspecificity of assets
D)Trademark and credibility

Answer 1

B

Question 2

It is more efficient for a mini-mill to use the worldwide market for scrap steel than to integrate upstream.

Answer 2

True

Question 3

Foreign outsourcing of service is commonly seen in economies that possess the skills and equipment required to produce those services for themselves.

Answer 3

False

Question 4

Identify the reason why U.S.Steel prefers to own iron ore mines.

A)It helps them to coordinate iron ore transport and furnace operations.
B)It reduces the company's raw material costs.
C)It helps them to inspect the quality of the ore.
D)It reduces the competition the company faces in the world steel market.

Question 5

If the assets used during the various stages of production are relatively nonspecific but the markets are highly uncertain, a short-term contract is likely to be the most efficient.

Question 6

Successive monopolies can earn larger profits by operating independently rather than working together or cooperating.

Question 7

The different stages of production of any commodity can be said to possess high volumetric interdependence if the output produced in any one of the stages affects the output produced during the subsequent stages.

Question 8

U.S.Steel considers the iron ore market thin because of:

A)the availability of wide range of ore producers.
B)the scarcity of alternative ore suppliers.
C)the volatility of ore prices.
D)the low deliverability risks.

Question 9

The ISO 9000 family of quality management and assurance procedures improve exchangeability by lowering the cost of obtaining information about the goods to be traded and the counterparties with whom individuals might trade.

Question 10

The obligations and prohibitions present in a contract between a franchiser and the franchisee are called vertical restraints.

Question 11

Iron mining, coal mining, and coke production constitute the _____ steps in steel making.

A)intermediate
B)upstream
C)final
D)introductory

Question 12

Since the government controls the maximum price pipelines can charge for transportation of natural gas, the pipelines going to the same destination usually compete by discounting rates below the legal maximum.

Question 13

Among the different stages of red wine production (selection of grapes, crushing, fermentation, blending and fining, adding preservatives, filtration and bottling), the first stage-selection of grapes is called the downstream and the final stage-packaging/bottling is called the upstream.

Question 14

Although coal and iron ore are both important raw materials used in steel production, coal is a more specific resource compared to iron ore.

Question 15

A thin market usually does not allow the use of futures contracts or other hedging tools.

Question 16

If different people own the different stages of production of a commodity, a contract or market relationship helps to minimize transaction risks and creates economic value.

Question 17

An asset's specificity can be measured in terms of the percentage of its cost that can be recovered if it is redeployed into its next most valuable use.

Question 18

Vertical integration of the different stages of spun yarn production increases transaction costs and the risk of opportunism since each stage employs highly specific assets.

Question 19

A firm that controls both the upstream as well as the downstream stages of production is said to be:

A)functionally integrated.
B)perpendicularly integrated.
C)vertically integrated.
D)horizontally integrated.

Question 20

When the ownership of the different stages of production of a commodity lies with different individuals, it becomes difficult to take decisions on capacity expansion because of all the following reasons, EXCEPT:

A)differences in attitudes toward risk.
B)differences in motivation.
C)different degrees of risk exposure.
D)different abilities to hedge themselves.

Question 21

Although U.S.Steel is integrated into iron ore mining, it currently does not own any of the mines that supply its coking coal because:

A)the company has a high requirement of coking coal which cannot be supplied by a single mine.
B)the coal prices are highly unpredictable and volatile.
C)there are a limited number of coal suppliers.
D)futures and options markets are available for coal.

Question 22

Coal producers cannot profit by acting opportunistically toward U.S.Steel because:

A)there is a wide range of coal producers and substitution possibilities are high.
B)coal is a highly specific resource and trades at competitive prices.
C)the company usually enters into a delivery contract to obtain coal.
D)the market for coal is thin.

Question 23

When two _____ monopolists merge, one division of the newly merged company will transfer its output to another division at its actual cost, instead of its profit maximizing price.

A)price discriminating
B)natural
C)output rationing
D)successive

Question 24

The invention of the Bessemer converter in 1856:

A)increased the cost of continuous and coordinated operations of a steel industry.
B)motivated downstream integration of the steel industry into coal mining.
C)increased the efficient scale of steel production.
D)increased volumetric interdependence between different stages of steel production.

Question 25

Successive monopolies face the problem of:

A)double marginalization.
B)volumetric interdependence.
C)opportunism.
D)predatory pricing.

Question 26

The figure given below represents two monopolists James and Jerry.James produces Good A using the input Good B which is produced by Jerry and has no other variable costs.James is the only consumer of Good B, and the marginal cost incurred by Jerry to produce Good B is zero.DA and DB represent the demand curves for Good A and Good B respectively.MRA and MRB represent the marginal revenue received from Good A and Good B respectively.It takes one unit of A to produce a unit of B.
Figure 14-1

Refer to Figure 14-1.What would be the combined profit earned by the two monopolists if they agree to merge?

A)$48
B)$24
C)$12
D)$36

Question 27

During the peak season, when demand for pipeline transport of natural gas at the maximum legally allowable price exceeds the available capacity:

A)buy-sell transactions take place.
B)pipeline owners vertically integrate into gas production.
C)price discrimination becomes prominent.
D)pipeline owners use discretionary powers to ration capacity to shippers.

Question 28

A monopolistic producer supplying raw materials to two industries one with a lower price elasticity of demand and the other with a high price elasticity of demand, practices _____ to prevent its low price elastic consumers (who have more elastic demands) from reselling its products to high price consumers (who have less elastic demands).

A)vertical integration
B)price discrimination
C)double marginalization
D)price control

Question 29

If assets are relatively _____, and uncertainty is _____, transactions usually take place in markets.

A)specific; quite low
B)nonspecific; quite low
C)specific; quite high
D)nonspecific; quite high

Question 30

The figure given below represents two monopolists James and Jerry.James produces Good A using the input Good B which is produced by Jerry and has no other variable costs.James is the only consumer of Good B, and the marginal cost incurred by Jerry to produce Good B is zero.DA and DB represent the demand curves for Good A and Good B respectively.MRA and MRB represent the marginal revenue received from Good A and Good B respectively.It takes one unit of A to produce a unit of B.
Figure 14-1

Refer to Figure 14-1.Calculate the profit earned by James in the absence of cooperation between the two monopolists.

A)$24
B)$12
C)$6
D)$36

Question 31

Which of the following properties is seen in a buy-sell transaction arranged by a pipeline?

A)Pipelines offer to resell gas to consumers even at a loss.
B)Gas producers offer to sell gas to the pipelines at a discounted prices.
C)Gas producers ration the amounts they supply to the pipelines.
D)Pipelines evade the legal ceiling on their transportation charge by bundling the gas with transportation service.

Question 32

A firm chooses vertical integration to reduce all of the following costs, EXCEPT:

A)the cost of investing in diversified assets.
B)the cost of finding a trading partner.
C)the cost of devising and enforcing an agreement.
D)the cost of evaluating the other party's performance.

Question 33

Which of the following is an advantage of mini-mills over vertically integrated giant mills?

A)The small size of mini-mills ensures economies of scale in steel production.
B)The small furnaces used in mini-mills depend less on coal and more on electricity.
C)The mini-mills do not require integration of casting and milling activities.
D)The small furnaces used by mini-mills can be operated as per the producer's will.

Question 34

_____ increases with the variability of outcomes and the underlying degree of randomness in the environment that can affect a business relationship.

A)The problem of double marginalization
B)Asset specificity
C)Uncertainty
D)Volumetric interdependence

Question 35

The figure given below represents two monopolists James and Jerry.James produces Good A using the input Good B which is produced by Jerry and has no other variable costs.James is the only consumer of Good B, and the marginal cost incurred by Jerry to produce Good B is zero.DA and DB represent the demand curves for Good A and Good B respectively.MRA and MRB represent the marginal revenue received from Good A and Good B respectively.It takes one unit of A to produce a unit of B.
Figure 14-1

Refer to Figure 7-1.Which of the following agreements between James and Jerry would be feasible?

A)James pays Jerry an amount above $48 only if Jerry agrees to produce 8 units.
B)James pays Jerry and amount below $24 only if Jerry agrees to produce 8 units.
C)James pays Jerry an amount above $24 only if Jerry agrees to produce 8 units.
D)James pays Jerry an amount below $12 only if Jerry agrees to produce 8 units.

Question 36

The figure given below represents two monopolists James and Jerry.James produces Good A using the input Good B which is produced by Jerry and has no other variable costs.James is the only consumer of Good B, and the marginal cost incurred by Jerry to produce Good B is zero.DA and DB represent the demand curves for Good A and Good B respectively.MRA and MRB represent the marginal revenue received from Good A and Good B respectively.It takes one unit of A to produce a unit of B.
Figure 14-1

Refer to Figure 7-1.Which of the following observations is true, assuming the two monopolists do not merge?

A)The price charged by James for his output is equal to that charged by Jerry.
B)The profit earned by James is almost double of that earned by Jerry.
C)The marginal cost of producing Good A is zero.
D)The marginal revenue curve for Good A is the demand curve for Good B.

Question 37

According to the text, which of the following developments have taken place in the American steel industry during the past 40 years?

A)The percentage of steel produced in vertically integrated steel plants has increased.
B)The percentage of steel produced in vertically integrated steel plants has decreased.
C)More steel makers have integrated vertically into coal mining.
D)More steel makers have integrated vertically into iron ore mining.

Question 38

The figure given below represents two monopolists James and Jerry.James produces Good A using the input Good B which is produced by Jerry and has no other variable costs.James is the only consumer of Good B, and the marginal cost incurred by Jerry to produce Good B is zero.DA and DB represent the demand curves for Good A and Good B respectively.MRA and MRB represent the marginal revenue received from Good A and Good B respectively.It takes one unit of A to produce a unit of B.
Figure 14-1

Refer to Figure 14-1.What would be Jerry's profit maximizing price-output combination if the two monopolists do not cooperate?

A)4 units at $9 each
B)4 units at $3 each
C)4 units at $6 each
D)8 units at $6 each

Question 39

The maximum price pipelines can charge for distributing gas:

A)is determined in a monopolistic market.
B)depends on the market demand and supply.
C)is set by the federal government.
D)is always above the legal minimum.

Question 40

If there is a low degree of uncertainty combined with a low degree of asset specificity, _____ will be efficient.

A)long-term contracts
B)short-term contracts
C)market transactions
D)vertical integration

Question 41

Which of the following observations about outsourcing is true for the U.S.economy?

A)The U.S.is the smallest international outsourcer in terms of dollar value.
B)About 30 percent of U.S.manufacturing costs were outsourced in 2003.
C)The highest percentage of outsourcing by U.S.businesses in 2003 was to other firms located in the United States.
D)Imports of business services by the U.S.made up around 2.5 percent of gross domestic product in 2003.

Question 42

Firms generally prefer not to outsource product design and manufacturing because:

A)these activities are common and standardized.
B)these operations are more or less static.
C)these operations involve a low investment.
D)these operations require investment in highly specific assets.

Question 43

Which of the following changes can facilitate the transfer or outsourcing of formerly internal activities of a firm?

A)Changes in technology and market structure
B)Decline in domestic input prices
C)Decline in net exports
D)Rapid pace of industrialization

Question 44

Explain why the production and milling of hot steel has a high volumetric interdependence?

Question 45

Which of the following exemplifies a vertical restraint imposed by a franchisor in a contract?

A)A clause prohibiting a franchisee from using the company trademark to support a political candidate.
B)A clause prohibiting a franchisee from announcing special offers during Christmas to attract customers.
C)A clause prohibiting a franchisee from bundling two products of the same company.
D)A clause stating the target sales to be achieved by the company during an accounting year.

Question 46

The arrival of inexpensive information technology, such as personal computers and inexpensive telecommunications:

A)discouraged de-integration.
B)increased the optimal size of firms.
C)shifted the long-run average cost (LRAC) curve of firms downward.
D)shifted the marginal cost of firms upward.

Question 47

Suppose a parent company producing sportswear decides take back some formerly franchised outlets and operate them with its own employees.This form of vertical integration will allow the parent company:

A)to practice price discrimination.
B)to charge a uniform price for its products across the globe.
C)to lower its costs of operation and increase sales.
D)to test operating techniques that might make the franchisees bettor competitors.

Question 48

A _____ between a parent company and the operator of a local outlet specifies each party's duties and the structure of payments that link them, and can turn the combined organization into a stronger competitor.

A)volumetric interdependence
B)franchise contract
C)joint venture
D)buy-sell transaction

Question 49

Which of the following exemplifies an opportunistic behavior by a franchisor arising out of incompleteness or ambiguity in a contract?

A)Providing inferior service in an attempt to cut operating costs.
B)Terminating a well-operated franchisee and converting the establishment into a profitable company-owned outlet.
C)Fixing exorbitant prices for products having relatively elastic demand.
D)Terminating a franchisee who had been using the company brand name to endorse products that the agreement says it cannot.

Question 50

Explain briefly why U.S.Steel prefers to own its mines, enrichment facilities, and ore carriers.

Question 51

How is a firm's vertical scope determined?

Question 52

_____ and _____ are major factors in de-integration, which act in opposite directions.

A)Vertical restraints; opportunism
B)Uncertainty; volumetric interdependence
C)Asset specificity; uncertainty
D)Volumetric interdependence; vertical restraints

Question 53

Which of the following statistics confirm the rise in de-integration in the U.S.post 1970s?

A)The average number of industrial sectors a firm operated in increased substantially in 1997.
B)Employment in the business services industry that supplied contract employees grew by almost five times as much as non-farm employment.
C)Between 1977 and 1999, imports of the U.S.firms from foreign affiliates as a percentage of total imports increased substantially.
D)Between 1977 and 1999, imports of the U.S.firms from unrelated suppliers as a percentage of total imports declined.

Question 54

What are the advantages of vertical integration?

Question 55

In order to lessen the monitoring problems and opportunistic behavior of a franchisor and a franchisee, franchise contracts:

A)create provisions for high liquidated damages.
B)are complete in all respect.
C)have similar fixed charge and royalty arrangements.
D)include certain flexible clauses.

Question 56

_____ is a monthly payment made by a franchisee to the franchisor usually a certain percentage of the former's gross revenue.

A)Royalty
B)Annuity
C)Contingent fee
D)Capitation fee

Question 57

Does U.S.Steel prefer to own coal mines? Give reason for your answer.

Question 58

Mention the reasons behind the de-integration of American Steel producers.

Question 59

_____ improves exchangeability, and reduces the cost of obtaining information about a good and about the parties involved in the transaction.

A)De-integration
B)Outsourcing
C)Vertical integration
D)Standardization

Question 60

Which of the following transactions can be categorized as outsourcing?

A)A U.S.furniture manufacturer buying a lumber facility.
B)A U.S.firm transferring some of its operations to its new subsidiary in India.
C)Nike selling its sportswear to customers through its franchisees across the world.
D)A U.S.cosmetics firm using an advertising agency to market its products.

Question 61

Explain how a vertical merger or an agreement between two vertically integrated firms can be strategically useful even if it neither lowers transaction costs nor cuts the risks of opportunism.

Question 62

Explain the three dimensions of uncertainty which affects the choice among markets, contracts, and integration.

Question 63

When are businesses likely to outsource some of their activities?

Question 64

Explain the problem encountered by successive monopolies? How can the supplier and the producer overcome this problem?

Question 65

Describe in brief the structure of a franchise contract.

Question 66

Why do vertical contracts impose restraints and obligations?