Firm S supplies inputs to firm B. Because producing the input is quite complicated, some defects are inevitable. Firm S can reduce the rate of defects at a cost. In turn, defective parts lower firm B's profits (because of lost sales and unhappy customers). The firms' profits and costs (in thousands of dollars) are shown in the table.
a. Should firm B insist on 0 percent defects? Why or why not?
b. What level of product quality is part of an efficient agreement? Explain.
|
0% Defects
|
B's Profit
100
|
S's Cost
80
|
6% Defects
|
B's Profit
50
|
S's Cost
25
|
|
2% Defects
|
86
|
58
|
8% Defects
|
26
|
20
|
|
4% Defects
|
72
|
37
|
10% Defects
|
24
|
16
|