Conferences at Department of Economics, University of Toronto, RCEF 2012: Cities, Open Economies, and Public Policy

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Quality and Scope in International Networks

Mengxiao Liu, Nathan Nunn, Daniel Trefler

Last modified: 2012-07-12

Abstract


This paper develops a theoretical framework about firms' quality, scope and boundary decisions. In our framework, a firm's choice of scope (or
number of suppliers) affects its revenue share in equilibrium. With a larger scope, the firm has to hire more suppliers, which means the firm as well as
each supplier get smaller shares of revenue in equilibrium, thus their incentive for investing in inputs qualities are lower, resulting in lower
quality outputs, and thus lower revenue. Therefore, there is a trade off between larger scope (which implies an output with higher functionality), and
higher revenue share (which improves the incentive of quality investments and implies an output with higher quality). In equilibrium, a firm's organizational
choices will depend both on its productivity, and the kind of industry it is in. In industries where scope and firm productivity are complements, higher
productivity firms choose to integrate and lower productivity firms choose to outsource. In industries where scope and firm productivity are substitute,
higher productivity firms choose to outsource while lower productivity firms choose to integrate.


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