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.