A simple model of outsourcing with Cournot competition

Abstract

The paper analyses a partial equilibrium outsourcing model with Cournot competition in intermediate good production. Final production is located in western Europe, whereas the intermediate good can be manufactured by a western (outsourcing) or eastern European supplier (offshore outsourcing). Interregional production (factor) allocation depending on factor prices and productivity levels is investigated analytically and graphically. The main results are: Higher production costs in one region reduce intermediate good production in both regions leading to a substitution effect between high- and low-skilled labour intensive inputs rather than between eastern and western low-skilled labour intensive inputs. The sensitivity of outsourcing activities to production cost changes is highest when the interregional cost differential is smallest.