Econ Micro (book Only)
Econ Micro (book Only)
6th Edition
ISBN: 9781337408066
Author: William A. McEachern
Publisher: Cengage Learning
Question
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Chapter 14, Problem 1P
To determine

The criteria that firms apply to decide whether to produce a component part or purchase it in the market.

Concept Introduction:

Firms have to list criteria before deciding how to produce a component, based on objectives like profit-making, the cost involved, production limitations like resource availability, etc.

Expert Solution & Answer
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Explanation of Solution

Firms always have to decide between making a component or buying it outside. Their decision is always based on criteria like profit expectation and relevant cost of decision making.

Opportunity cost is the opportunity lost by choosing one alternative over the other. Therefore, such decision is based on total economic cost (opportunity cost + external outlays) between the two alternatives available. The one which is lower would be a choice for them. The relevant cost is different in making and buying as the variable and fixed cost differ. So, if the variable cost in contracting out is low, the firms would like to go for buying from the market. However, reliability on quality, timely delivery, and control over operations is questionable.

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