. Make-or-Buy Decision (16 points)

Best Boards, Inc., is a company producing a variety of boards. Among them, Best Boards(BB) can produce wakeboards at a cost of $95 for per wakeboard. And Jim Muller, vice president of operations, received a bid for $75 per board from an outside manufacturer, First-Class (FC). FC uses a fully automated manufacturing process, and can therefore produce a wakeboard at a cost of $55. Currently FC produces at its capacity, so when selling the wakeboards to BB it cannot sell them to another customer, who can pay $ 65 for each wakeboard.

a) (2 points) what is the total surplus per unit that could be realized when BB procured the wakeboards from FC (instead of producing them internally)?

b) (4 points) what is the highest acceptable price for BB(denoted ), and which is the lowest acceptable price for FC(denoted )? For each of these two prices, derive the share of the total surplus for BB and FC respectively.

c) (4 points) Assuming Nash bargaining, what is the price per unit that BB and FC will agree on? Given this price, what is the share of the total surplus for BB and FC respectively? what are the rents for BB and FC respectively?

d) (6 points) Draw a diagram with the share of the total surplus (payoff) for BB on the vertical axis, and the share of the total surplus for FC on the horizontal axis.

Then,

(i) (2 points) Use your results from part a) to illustrate the bargaining frontier for the two firms on the diagram.

(ii) (2 points) Use your results from part b) to identify the feasible payoff allocations on the diagram.

(iii) (2 points) Use your results from part c) to identify the Nash bargaining outcome on the diagram.

Note: Your diagram should show specific numbers for the share of the total surplus for the two firms. 3