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Losing Under Contract: Transaction-Cost Externalities and Spot Market Disintegration

Author

Listed:
  • Roberts Michael J

    (United States Department of Agriculture, Economic Research Service)

  • Key Nigel

    (United States Department of Agriculture, Economic Research Service)

Abstract

Standard economic intuition of revealed preference implies that when two parties freely enter into a contract then neither should be worse off. In this study, we develop a simple model showing that introducing the opportunity to contract can lower welfare for some, and perhaps all, contracting parties. We consider a situation where processors can obtain inputs from suppliers (farmers) using either a spot market or contractual arrangements, and where spot market transaction costs depends on the volume of trade in the spot market. We show that contracting parties may lose when more contracting results in higher transaction costs for spot market participants. At the margin, firms and input suppliers gain from signing contracts. However, contracting raises spot-market transaction costs for those who do not sign contracts, which provides a greater incentive for others to sign contracts, ultimately inducing more contracting than optimal. The model demonstrates why structural or organizational change may be rapid and why the private minimization of transaction costs may not lead to optimal institutional arrangements.

Suggested Citation

  • Roberts Michael J & Key Nigel, 2005. "Losing Under Contract: Transaction-Cost Externalities and Spot Market Disintegration," Journal of Agricultural & Food Industrial Organization, De Gruyter, vol. 3(2), pages 1-19, April.
  • Handle: RePEc:bpj:bjafio:v:3:y:2005:i:2:n:2
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    Cited by:

    1. Marcel Fafchamps & Ruth Vargas Hill, 2008. "Price Transmission and Trader Entry in Domestic Commodity Markets," Economic Development and Cultural Change, University of Chicago Press, vol. 56, pages 729-766.
    2. Volpe, Richard J., III, 2006. "Exploring the Potential Effects of Organic Production on Contracting in American Agribusiness," 2006 Annual meeting, July 23-26, Long Beach, CA 21086, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).

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