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Long-Term Contracting with Markovian Consumers

  • Marco Battaglini

To study how a firm can capitalize on a long-term customer relationship, we characterize the optimal contract between a monopolist and a consumer whose preferences follow a Markov process. The optimal contract is nonstationary and has infinite memory, but is described by a simple state variable. Under general conditions, supply converges to the efficient level for any degree of persistence of the types and along any history, though convergence is history-dependent. In contrast, as with constant types, the optimal contract can be renegotiation-proof, even with highly persistent types. These properties provide insights into the optimal ownership structure of the production technology.

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 95 (2005)
Issue (Month): 3 (June)
Pages: 637-658

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Handle: RePEc:aea:aecrev:v:95:y:2005:i:3:p:637-658
Note: DOI: 10.1257/0002828054201369
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