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Efficient Exclusion

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Author Info
Moen, Espen R
Riis, Christian

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Abstract

In an important paper, Aghion and Bolton (1987) argue that a buyer and a seller may agree on high liquidation damages in order to extract rents from future suppliers. As this may distort future trade, it may be socially wasteful. We argue that Aghion and Bolton's analysis is incomplete in some respects, as they do not model the entry of new suppliers. We construct a model where entry is costly, so that entering suppliers have to earn a quasi-rent in order to recoup the entry cost. Reducing an entrant's profits by the help of a breach penalty then reduces the probability of entry in the first place, thus making a breach penalty less attractive for the contracting parties. We show that the initial buyer and seller only have incentives to include a breach penalty if there is excessive entry without it. Forcing the initial buyer and seller to eliminate the breach penalty reduces welfare.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5257.

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Date of creation: Sep 2005
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Handle: RePEc:cpr:ceprdp:5257

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Related research
Keywords: breach penalties efficiency entry exclusive contracts

Find related papers by JEL classification:
L42 - Industrial Organization - - Antitrust Issues and Policies - - - Vertical Restraints; Resale Price Maintenance; Quantity Discounts

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References listed on IDEAS
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  1. Paul Klemperer, 2004. "Auctions: Theory and Practice," Economics Papers 2004-W09, Economics Group, Nuffield College, University of Oxford. [Downloadable!]
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  2. Peter A. Diamond & Eric Maskin, 1979. "An Equilibrium Analysis of Search and Breach of Contract, I: Steady States," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 282-316, Spring. [Downloadable!] (restricted)
  3. Aghion, Philippe & Bolton, Patrick, 1987. "Contracts as a Barrier to Entry," American Economic Review, American Economic Association, vol. 77(3), pages 388-401, June.
  4. Engelbrecht-Wiggans Richard, 1993. "Optimal Auctions Revisited," Games and Economic Behavior, Elsevier, vol. 5(2), pages 227-239, April. [Downloadable!] (restricted)
  5. Peters, Michael, 1997. "A Competitive Distribution of Auctions," Review of Economic Studies, Blackwell Publishing, vol. 64(1), pages 97-123, January. [Downloadable!] (restricted)
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  6. Burguet, Roberto & Sakovics, Jozsef, 1996. "Reserve Prices without Commitment," Games and Economic Behavior, Elsevier, vol. 15(2), pages 149-164, August. [Downloadable!] (restricted)
  7. B. Douglas Bernheim & Michael D. Whinston, 1998. "Exclusive Dealing," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 64-103, February. [Downloadable!] (restricted)
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  8. Innes, Robert & Sexton, Richard J, 1994. "Strategic Buyers and Exclusionary Contracts," American Economic Review, American Economic Association, vol. 84(3), pages 566-84, June. [Downloadable!] (restricted)
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