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Contractual Incompleteness and the Nature of Market Interactions

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Author Info
Brown, Martin
Falk, Armin
Fehr, Ernst

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Abstract

We provide experimental evidence that contractual incompleteness, ie, the absence of third party enforcement of workers’ effort or the quality of the good traded causes a fundamental change in the nature of market interactions. If contracts are complete the vast majority of trades are initiated by public offers. Most trades take place in one-shot transactions and the contracting parties are indifferent with regard to the identity of their trading partner. Moreover, the short side of the market attempts to appropriate the whole gains from trade, which causes much disagreement about contract terms. If contracts are incomplete the vast majority of trades are initiated by private offers. The contracting parties form long-term relations and the provision of low effort or bad quality is penalized by the termination of the relationship. The threat of terminating the relation turns out to be an extremely powerful discipline device. Markets with incomplete contracts resemble a collection of bilateral trading islands rather than a competitive market. The short side of the market shares the gains from trade with the long side of the market so that there is little disagreement about contract terms. Our results support theories of the labour market that are based on the idea that unemployment is a worker discipline device.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3272.

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Date of creation: Mar 2002
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Handle: RePEc:cpr:ceprdp:3272

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Related research
Keywords: contract enforcement; fairness preferences; incomplete contract; involuntary unemployment; market interaction; repeated transaction;

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Find related papers by JEL classification:
C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
D20 - Microeconomics - - Production and Organizations - - - General
D40 - Microeconomics - - Market Structure and Pricing - - - General

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Brown, Martin & Falk, Armin & Fehr, Ernst, 2003. "Relational Contracts and the Nature of Market Interactions," IZA Discussion Papers 897, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  2. Jean-Robert Tyran & Elke Renner, 2003. "Price Rigidity in Customer Markets," University of St. Gallen Department of Economics working paper series 2003 2003-16, Department of Economics, University of St. Gallen. [Downloadable!]
    Other versions:
  3. Jordi Brandts & Arno Riedl & Frans van Winden, 2004. "Competition and Well-Being," Tinbergen Institute Discussion Papers 04-041/1, Tinbergen Institute. [Downloadable!]
    Other versions:
  4. William Fuchs, 2005. "Contracting with Repeated Moral Hazard and Private Evaluations," Game Theory and Information 0511007, EconWPA. [Downloadable!]
    Other versions:
  5. Giovannetti, E. & Neuhoff, K. & Spagnolo, G., 2005. "Agglomeration in Internet Co-operation Peering Agreements," Cambridge Working Papers in Economics 0505, Faculty of Economics, University of Cambridge. [Downloadable!]
  6. Bewley, Truman, 2004. "Fairness, Reciprocity, and Wage Rigidity," IZA Discussion Papers 1137, Institute for the Study of Labor (IZA). [Downloadable!]
  7. Blonski, Matthias & Spagnolo, Giancarlo, 2002. "Relational Contracts and Property Rights," CEPR Discussion Papers 3460, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  8. Truman F. Bewley, 2002. "Fairness, Reciprocity, and Wage Rigidity," Cowles Foundation Discussion Papers 1383, Cowles Foundation, Yale University. [Downloadable!]
  9. Michael Kosfeld, . "Network Experiments," IEW - Working Papers iewwp152, Institute for Empirical Research in Economics - IEW. [Downloadable!]
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