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Contract Duration and the Costs of Market Transactions

Author

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  • Alexander MacKay

Abstract

The optimal duration of a supply contract balances the costs of re-selecting a supplier against the costs of being matched to an inefficient supplier when the contract lasts too long. I develop a structural model of contract duration that captures this trade-off and provide an empirical strategy for quantifying (unobserved) transaction costs. I estimate the model using federal supply contracts for a standardized product, where suppliers are selected by procurement auctions. The estimated transaction costs are substantially greater than consumer switching costs and a significant portion of total buyer costs. Counterfactuals illustrate the importance of accounting for the duration margin.

Suggested Citation

  • Alexander MacKay, 2022. "Contract Duration and the Costs of Market Transactions," American Economic Journal: Microeconomics, American Economic Association, vol. 14(3), pages 164-212, August.
    • Handle: RePEc:aea:aejmic:v:14:y:2022:i:3:p:164-212
    DOI: 10.1257/mic.20200128
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    More about this item

    JEL classification:

    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • H57 - Public Economics - - National Government Expenditures and Related Policies - - - Procurement
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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