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When Do Input Prices Matter For Make-Or-Buy Decisions?

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Abstract

We investigate input pricing regimes that induce efficient make-or-buy decisions by entrants when there is constant returns in the production of the input(s) and simultaneous noncooperative price competition in downstream retail markets. A necessary and sufficient condition for efficient make-or-buy decisions is derived. This condition shows that input prices are relevant for make-or-buy decisions except under restrictive and often unverifiable assumptions on the demand structure, and that the least informationally-demanding way to ensure efficient make-or-buy decisions is to price inputs at marginal cost. The extent to which input prices can depart from marginal cost while still inducing efficient make-or-buy decisions depends on the relative efficiency of the incumbent and the demand displacement ratio, with significant departures possible even for modest efficiency differences when products are nearly homogeneous.

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  • David Mandy, 2007. "When Do Input Prices Matter For Make-Or-Buy Decisions?," Working Papers 0701, Department of Economics, University of Missouri.
    • Handle: RePEc:umc:wpaper:0701
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    More about this item

    Keywords

    Input Pricing Policy; Productive Efficiency.;

    JEL classification:

    • L5 - Industrial Organization - - Regulation and Industrial Policy
    • L9 - Industrial Organization - - Industry Studies: Transportation and Utilities

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