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Bilateral Contracts

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  • Jerry R. Green
  • Seppo Honkapohja

Abstract

The basic form of economic exchange is a bilateral relationship between buyer and seller. If economic conditions are common knowledge there is no problem in principle to determine the efficient quantity to trade. But if benefits are known only to the buyer and costs are known only to the seller a situation of bargaining under incomplete information results. Instead of relying on the vagaries of a bargaining outcome, which might be quite costly to implement, economic inefficiency is likely to be improved by a contractual arrangement that could be agreed upon in advance. In such contracts various aspects of the exchange could be allocated to the two parties involved. For example, a price per unit might be fixed in advance and the buyer might be allowed to name his quantity in the light of the information he has about benefits. A more complex version would present the buyer with a non-linear price schedule. Alternatively the supplies might be given control. While these solutions are fairly well understood, there are other types of arrangements in which control is mutual. This paper studies contracts of this nature. We examine the feasibility of implementing various agreements and the nature of optimal bilateral contracts under these informational circumstances. When the random influences impact both parties significantly, full efficiency is not attainable. We show that contracts involving mutual control might sometimes be superior to the best contract giving one side or the other exclusive dominance.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0721.

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Date of creation: Jul 1981
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Publication status: published as Green, Jerry, and Seppo Honkapohja. "Bilateral Contracts." Journal of Mathematical Economics, Vol. 11, No. 2, (1983), pp. 171-187.
Handle: RePEc:nbr:nberwo:0721

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  1. Spence, Michael, 1977. "Nonlinear prices and welfare," Journal of Public Economics, Elsevier, vol. 8(1), pages 1-18, August.
  2. M. L. Weitzman, 1973. "Prices vs. Quantities," Working papers 106, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Laffont, Jean-Jacques & Maskin, Eric, 1980. "A Differential Approach to Dominant Strategy Mechanisms," Econometrica, Econometric Society, vol. 48(6), pages 1507-20, September.
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Cited by:
  1. Edward P. Lazear, 1982. "Severance Pay, Pensions, and Efficient Mobility," NBER Working Papers 0854, National Bureau of Economic Research, Inc.
  2. Russell Cooper, 1983. "Worker Asymmetric Information and Involuntary Unemployment," Cowles Foundation Discussion Papers 671R, Cowles Foundation for Research in Economics, Yale University, revised Apr 1984.

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