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Efficient Exclusion

  • Moen, Espen R
  • Riis, Christian

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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  1. Motta,Massimo, 2004. "Competition Policy," Cambridge Books, Cambridge University Press, number 9780521816632.
  2. Michael Peters, 1995. "A Competitive Distribution of Auctions," Working Papers peters-95-03, University of Toronto, Department of Economics.
  3. Bernheim, B.D., 1992. "Exclusive Dealing," Harvard Institute of Economic Research Working Papers 1622, Harvard - Institute of Economic Research.
  4. Burguet, Roberto & Sakovics, Jozsef, 1996. "Reserve Prices without Commitment," Games and Economic Behavior, Elsevier, vol. 15(2), pages 149-164, August.
  5. Paul Klemperer, 2004. "Auctions: Theory and Practice," Economics Series Working Papers 2004-W09, University of Oxford, Department of Economics.
  6. Aghion, Philippe & Bolton, Patrick, 1987. "Contracts as a Barrier to Entry," American Economic Review, American Economic Association, vol. 77(3), pages 388-401, June.
  7. Innes, Robert & Sexton, Richard J, 1994. "Strategic Buyers and Exclusionary Contracts," American Economic Review, American Economic Association, vol. 84(3), pages 566-84, June.
  8. Motta,Massimo, 2004. "Competition Policy," Cambridge Books, Cambridge University Press, number 9780521016919.
  9. McAfee, R Preston, 1993. "Mechanism Design by Competing Sellers," Econometrica, Econometric Society, vol. 61(6), pages 1281-1312, November.
  10. Engelbrecht-Wiggans Richard, 1993. "Optimal Auctions Revisited," Games and Economic Behavior, Elsevier, vol. 5(2), pages 227-239, April.
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