HORIZONTAL SUBCONTRACTING

Horizontal subcontracting agreements between rival firms, each of whic h is capable of producing and marketing its products independently, ar e common. This article explains this practice and evaluates its welfar e implications. The analysis shows that firms with asymmetric convex c osts can use horizontal subcontracting to allocate production more eff iciently between them and consequently generate a mutually beneficial surplus. For a wide range of parameters, this increase in production e fficiency leads to an increase in industry output. The counter-intuiti ve result is that welfare is thereby enhanced. In fact, even when indu stry output falls, welfare can still increase if production costs are sufficiently lowered.