Explain how transaction cost analysis can provide insights into vertical integration decisions.
What will be an ideal response?
According to this perspective, every market transaction involves some transaction costs. First, a decision to purchase an input from an outside source leads to search costs (i.e., the cost to find where it is available, the level of quality, etc.). Second, there are costs associated with negotiating. Third, a contract needs to be written, spelling out future possible contingencies. Fourth, parties in a contract have to monitor each other. Finally, if a party does not comply with the terms of the contract, there are enforcement costs. Many of these transaction costs can be avoided by internalizing the activity-in other words, by producing the input in-house.
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