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Fixed Price versus Spot Price Contracts: A Study in Risk Allocation

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  • Polinsky, A Mitchell

Abstract

Thi spaper is concerned with the risk-allocation effects of alternative types of contracts used to set the price of a good tobe delivered in the future. Under a fixed price contract, the price is specified in advance. Under a spot price contract, the price is the price prevailing in the spot market at the time of delivery.These contract forms are examined in the context of a market in which sellers have uncertain production costs and buyers have uncertain valuations. The paper derives and interprets a general condition determining which contract form would be preferred when the seller and/or the buyer is risk averse. In addition, an example is provided in which a spot price contract with a floor price is superior both to a "pure" spot price contract and a fixed price contract.

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Bibliographic Info

Article provided by Oxford University Press in its journal Journal of Law, Economics and Organization.

Volume (Year): 3 (1987)
Issue (Month): 1 (Spring)
Pages: 27-46

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Handle: RePEc:oup:jleorg:v:3:y:1987:i:1:p:27-46

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References

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  1. J.K. Sebenius & P.J.E. Stan, 1982. "Risk-Spreading Properties of Common Tax and Contract Instruments," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 555-560, Autumn.
  2. Feder, Gershon & Just, Richard E & Schmitz, Andrew, 1980. "Futures Markets and the Theory of the Firm under Price Uncertainty," The Quarterly Journal of Economics, MIT Press, vol. 94(2), pages 317-28, March.
  3. Shavell, Steven, 1976. "Sharing Risks of Deferred Payment," Journal of Political Economy, University of Chicago Press, vol. 84(1), pages 161-68, February.
  4. Paul Joskow, 1984. "Vertical Integration and Long Term Contracts: The Case of Coal Burning Electric Generating Plants," Working papers 361, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Holthausen, Duncan M, 1979. "Hedging and the Competitive Firm under Price Uncertainty," American Economic Review, American Economic Association, vol. 69(5), pages 989-95, December.
  6. Ronald I. McKinnon, 1967. "Futures Markets, Buffer Stocks, and Income Stability for Primary Producers," Journal of Political Economy, University of Chicago Press, vol. 75, pages 844.
  7. H. Stuart Burness & W. David Montgomery & James P. Quirk, 1980. "The Turnkey Era in Nuclear Power," Land Economics, University of Wisconsin Press, vol. 56(2), pages 188-202.
  8. Alan J. Marcus, 1982. "Risk Sharing and the Theory of the Firm," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 369-378, Autumn.
  9. Cheung, Steven N S, 1969. "Transaction Costs, Risk Aversion, and the Choice of Contractual Arrangements," Journal of Law and Economics, University of Chicago Press, vol. 12(1), pages 23-42, April.
  10. Newbery, David M, 1989. "The Theory of Food Price Stabilisation," Economic Journal, Royal Economic Society, vol. 99(398), pages 1065-82, December.
  11. Yakov Amihud & Baruch Lev, 1981. "Risk Reduction as a Managerial Motive for Conglomerate Mergers," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 605-617, Autumn.
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