Price and Quantity in Offshoring¤
Ben G. Li
Boston College

Zhihong Yu
University of Nottingham

Xufei Zhang
Middlesex University
First draft: March 14, 2014
This draft: May 3, 2015

Abstract
Since products made through offshoring are customized by producers for their
clients, offshoring transactions respond to external shocks in a unique way. We examine
two margins—price and quantity—of offshoring transactions with real exchange
rate shocks as an example of demand shocks. Shocks aggravate the incentive
incompatibility between producers and clients in offshoring. Offshore producers
have incentives to adjust prices and disincentives to adjust quantities. This
forms a contrast with international trade in standard models, where complete contracts
guarantee incentive-compatibility in price and quantity adjustments. If the
ownership of either the producer or the inputs alters, the adjustments at the two
margins will differ accordingly. Our predictions are supported by empirical evidence.
JEL codes: F14, F23, F31
Keywords: offshoring, incomplete contract, hold-up problem, exchange rate