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Integration vs. Outsourcing in Industry Equilibrium

  • Gene Grossman
  • Elhanan Helpman

We develop an equilibrium model of industrial structure in which the organization of firms is endogenous. Differentiated consumer products can be produced either by vertically integrated firms or by pairs of specialized companies. Production of each variety of consumer good requires a unique, specialized component. Vertically integrated firms can manufacture the components they need in the quantity and type that maximizes profits, but they face a relatively high cost due to diseconomies of scope. Specialized firms can produce at lower cost, but outsourcing imposes costs due to search frictions and imperfect contracting. We study the equilibrium mode of organization when inputs are fully or partially specialized. We consider how the degree of competition in the industry, the nature of the search technology, the division of bargaining strength between intermediate and final producers, and the sensitivity of manufacturing costs to input characteristics affect the equilibrium organizational form.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 460.

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Date of creation: 2001
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Handle: RePEc:ces:ceswps:_460
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  1. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Econometrica, Econometric Society, vol. 62(2), pages 257-82, March.
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  11. Perry, Martin K., 1989. "Vertical integration: Determinants and effects," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 4, pages 183-255 Elsevier.
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  13. David L. Hummels & Dana Rapoport & Kei-Mu Yi, 1998. "Vertical specialization and the changing nature of world trade," Economic Policy Review, Federal Reserve Bank of New York, issue Jun, pages 79-99.
  14. Abraham, Katharine G & Taylor, Susan K, 1996. "Firms' Use of Outside Contractors: Theory and Evidence," Journal of Labor Economics, University of Chicago Press, vol. 14(3), pages 394-424, July.
  15. Ilya Segal, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 57-82.
  16. Peter A. Diamond, 1982. "Wage Determination and Efficiency in Search Equilibrium," Review of Economic Studies, Oxford University Press, vol. 49(2), pages 217-227.
  17. Eric Maskin & Jean Tirole, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 83-114.
  18. Yeats, Alexander J., 1998. "Just how big is global production sharing?," Policy Research Working Paper Series 1871, The World Bank.
  19. John McLaren, 2000. ""Globalization" and Vertical Structure," American Economic Review, American Economic Association, vol. 90(5), pages 1239-1254, December.
  20. Riordan, Michael H. & Williamson, Oliver E., 1985. "Asset specificity and economic organization," International Journal of Industrial Organization, Elsevier, vol. 3(4), pages 365-378, December.
  21. Oliver Jean Blanchard & Peter Diamond, 1989. "The Beveridge Curve," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1), pages 1-76.
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