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.

Transcribed Image Text:

B's Profit 0% Defects 2% Defects 4% Defects 100 86 72 S's Cost 80 58 37 6% Defects 8% Defects 10% Defects B's Profit 50 26 24 S's Cost 25 20 16