Question

Explain the O-Ring model and the effect of industry bottlenecks?

Answer 1

The O- ring model deals with how firms and workers are organised in an economy in the production sector where just one weak link in the process can destroy the entire value of the chain. The model is basically due to an economist Michael Kramer.

As per him, a production process follows an O-ring model if the production depends on completing a series of tasks. the failure of one task in that series reduce down the value of the entire product perhaps to zero plus the quality cant be substitued with the quantity. For eg. microchip. A single dust particle can ruin the whole of the microchip.

Assume there are N tasks, one worker per task. Let the quality of worker lies between o and 1. So q₁=.9 means that 90% chance of completing task perfectly and 10% chance of failure. The output Y= N*(q_i) .

If N=10 and q=.99: Y= 10* (.99)¹⁰=9.04 ; if q=.95: Y= 10* (.95)¹⁰=5.99. So just a small decrease in quality level, the output declines by a large amount.

AN important implication of O model is quality matching. It says that output would be higher if we put all the high workers together and low-quality workers together than the mix of qualities. In a competitive economy with quality matching, the higher output means the higher wages. The wage/output curve is non-linear.

Implication: If the countries have differences in the quality of workers, then the one with low-quality worker would have much much smaller GDP per capita than the other nation even if the difference is not substantial. In the model, the workers performing the same task earn higher wages in a high skill firm than in a low skill firm. (the high-quality workers work with high-quality colleagues are paid higher because of higher value of output they produce). If there are a large number of high quality of workers around you in an economy, you have greater incentive to invest in skill learning. There are possibilities of multiple equilibria. One where everyone wants to be highly skilled and one where no one is getting high skills because they don't find it worthwhile.

The rule also applies to the capital. the high-quality capital also wants to work with the high-quality workers. the high skilled workers are basically employed with the expensive machines. for eg, in poor countries, the workers are mostly in less capital intensive production due to the low skill such as agriculture leading to the flight of capital.

b. Industry Bottlenecks:

Suppose there are N number of industries. each performing a given task. Suppose that quality falls by half in just two of the industries. the output would thus fall by (q₁*q₂) which is by (1/2*1/2) or 75%. moreover, the wages in other sectors would also fall. why? Since the total value of the product has fallen. the fallen wages would then reduce the incentive to invest in quality in other sectors also which in long run would further reduce the output of the economy. SO there would be bottleneck not just in that sector but also in other sectors because we have complementarities; when one sector goes down, other also goes down.