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Optimal Contracts with Lock-In

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  • Joseph Farrell and Carl Shapiro.

Abstract

The authors analyze incomplete long-term contracts when buyers incur relationship-specific set-up costs and sellers choose product or service quality that is not verifiable to third parties. If set-up costs are observable, the first-best outcome can be achieved even though contracts cannot enforceably specify quality; this does not even require long-term contracts. If set-up costs are unobservable, however, then long-term price contracts can strictly outperform short-term contracts. Equilibrium may involve either inefficiently low quality with no buyer switching or efficient quality with inefficient switching. A policy of taxing switching, or the availability of "budget-breaking" third parties, can improve welfare. Copyright 1989 by American Economic Association.

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Bibliographic Info

Paper provided by University of California at Berkeley in its series Economics Working Papers with number 8758.

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Date of creation: 01 Oct 1987
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Handle: RePEc:ucb:calbwp:8758

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Postal: University of California at Berkeley, Berkeley, CA USA
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Web page: http://www.haas.berkeley.edu/groups/iber/wps/econwp.html
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Cited by:
  1. Keisuke Hattori & Amihai Glazer, 2013. "How to Commit to a Future Price," Working Papers 131402, University of California-Irvine, Department of Economics.
  2. Anne Perrot, 1995. "Ouverture à la concurrence dans les réseaux : l'approche stratégique de l'économie des réseaux," Économie et Prévision, Programme National Persée, vol. 119(3), pages 59-71.
  3. Kerem Cakirer, 2007. "A Fixed Effect Model of Endogenous Integration Decision and Its Competitive Effects," Working Papers 2007-18, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  4. Ljungqvist, Alexander P & Wilhelm Jr, William J, 2001. "The Seven Percent Solution? An International Perspective On Underwriting Spreads," CEPR Discussion Papers 2736, C.E.P.R. Discussion Papers.
  5. Michael Waldman, 2004. "Antitrust Perspectives for Durable-Goods Markets," CESifo Working Paper Series 1306, CESifo Group Munich.
  6. Matthew Ellman, 2006. "The optimal length of contracts with application to outsourcing," Economics Working Papers 965, Department of Economics and Business, Universitat Pompeu Fabra.
  7. Bijl, P.W.J. de, 1996. "Essays in Industrial Organization and Management Strategy," Open Access publications from Tilburg University urn:nbn:nl:ui:12-73588, Tilburg University.
  8. Dennis W. Carlton & Michael Waldman, 2001. "Competition, Monopoly, and Aftermarkets," NBER Working Papers 8086, National Bureau of Economic Research, Inc.
  9. A. Jorge Padilla, 1991. "Consumer switching costs: a survey," Investigaciones Economicas, Fundación SEPI, vol. 15(3), pages 485-504, September.
  10. Dennis W. Carlton & Michael Waldman, 2005. "Tying, Upgrades, and Switching Costs in Durable-Goods Markets," NBER Working Papers 11407, National Bureau of Economic Research, Inc.
  11. Claudio Agostini, 2005. "El Mercado de Transporte Aéreo: Lecciones para Chile de una Revisión de la Literatura," ILADES-Georgetown University Working Papers inv163, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
  12. Nicholas Economides, . "Network Economics with Application to Finance," Financial Networks _004, Economics of Networks.
  13. Emi Nakamura & Jon Steinsson, 2005. "Price Setting in a Forward-Looking Customer Market," Macroeconomics 0509010, EconWPA.
  14. Bijl, P.W.J. de, 1995. "Aftermarkets: The monopoly case," Discussion Paper 1995-102, Tilburg University, Center for Economic Research.
  15. Constanza M. Fosco Perea M, . "Ambigüedad estratégica en contratos públicos de suministro," ILADES-Georgetown University Working Papers inv127, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.

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