Optimal Contracts with Lock-In
AbstractThe authors analyze incomplete long-term contracts when buyers incur relationship-specific set-up costs and sellers choose product or service quality that is not verifiable to third parties. If set-up costs are observable, the first-best outcome can be achieved even though contracts cannot enforceably specify quality; this does not even require long-term contracts. If set-up costs are unobservable, however, then long-term price contracts can strictly outperform short-term contracts. Equilibrium may involve either inefficiently low quality with no buyer switching or efficient quality with inefficient switching. A policy of taxing switching, or the availability of "budget-breaking" third parties, can improve welfare. Copyright 1989 by American Economic Association.
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Bibliographic InfoArticle provided by American Economic Association in its journal American Economic Review.
Volume (Year): 79 (1989)
Issue (Month): 1 (March)
Other versions of this item:
- Joseph Farrell and Carl Shapiro., 1987. "Optimal Contracts with Lock-In," Economics Working Papers 8758, University of California at Berkeley.
- Farrell, Joseph & Shapiro, Carl, 1987. "Optimal Contracts with Lock-In," Department of Economics, Working Paper Series qt19f324hf, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
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