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Contractual Incompleteness and the Nature of Market Interactions

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  • Martin Brown
  • Armin Falk
  • Ernst Fehr

Abstract

We provide experimental evidence that contractual incompleteness, i.e., the absence of third party enforcement of workers� effort or the quality of the good traded, causes a fundamental change in the nature of market interactions. If contracts are complete the vast majority of trades are initiated by public offers. Most trades take place in one-shot transactions and the contracting parties are indifferent with regard to the identity of their trading partner. Moreover, the short side of the market attempts to appropriate the whole gains from trade, which causes much disagreement about contract terms. If contracts are incomplete the vast majority of trades are initiated by private offers. The contracting parties form long-term relations and the provision of low effort or bad quality is penalized by the termination of the relationship. The threat of terminating the relation turns out to be an extremely powerful discipline device. Markets with incomplete contracts resemble a collection of bilateral trading islands rather than a competitive market. The short side of the market shares the gains from trade with the long side of the market so that there is little disagreement about contract terms. Our results support theories of the labor market that are based on the idea that unemployment is a worker discipline device.

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  • Martin Brown & Armin Falk & Ernst Fehr, "undated". "Contractual Incompleteness and the Nature of Market Interactions," IEW - Working Papers 038, Institute for Empirical Research in Economics - University of Zurich.
  • Handle: RePEc:zur:iewwpx:038
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    Cited by:

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    2. Fredrik Hansen, 2007. "Setting the scene with 'firms' and 'workers'," Journal of Economic Methodology, Taylor & Francis Journals, vol. 14(3), pages 339-352.
    3. Gennady Bilych, 2013. "What Is There in Common between Arab Revolutions and the Coase Theorem?," Business and Economic Research, Macrothink Institute, vol. 3(1), pages 126-152, June.
    4. Michael Kosfeld, "undated". "Network Experiments," IEW - Working Papers 152, Institute for Empirical Research in Economics - University of Zurich.
    5. Schlicht, Ekkehart, 2020. "The Homo Economicus Under Experimental Attack," Discussion Papers in Economics 74501, University of Munich, Department of Economics.
    6. Renner, Elke & Tyran, Jean-Robert, 2004. "Price rigidity in customer markets," Journal of Economic Behavior & Organization, Elsevier, vol. 55(4), pages 575-593, December.
    7. Bewley, Truman, 2004. "Fairness, Reciprocity, and Wage Rigidity," IZA Discussion Papers 1137, Institute of Labor Economics (IZA).
    8. Ekkehart Schlicht, 2008. "Consistency in Organization," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 164(4), pages 612-623, December.
    9. Schlicht, Ekkehart, 2002. "Der homo oeconomicus unter experimentellem Beschuß," Discussion Papers in Economics 70965, University of Munich, Department of Economics.
    10. William Fuchs, 2007. "Contracting with Repeated Moral Hazard and Private Evaluations," American Economic Review, American Economic Association, vol. 97(4), pages 1432-1448, September.
    11. Sergio G. Lazzarini & Gary J. Miller & Todd R. Zenger, 2008. "Dealing with the Paradox of Embeddedness: The Role of Contracts and Trust in Facilitating Movement Out of Committed Relationships," Organization Science, INFORMS, vol. 19(5), pages 709-728, October.
    12. Gennady Bilych, 2013. "Marx¡¯s Labor Theory of Value. Misleading or Truth?," Business and Economic Research, Macrothink Institute, vol. 3(1), pages 212-226, June.
    13. Truman F. Bewley, 2002. "Fairness, Reciprocity, and Wage Rigidity," Cowles Foundation Discussion Papers 1383, Cowles Foundation for Research in Economics, Yale University.
    14. Martin Brown & Armin Falk & Ernst Fehr, 2004. "Relational Contracts and the Nature of Market Interactions," Econometrica, Econometric Society, vol. 72(3), pages 747-780, May.
    15. Giovannetti, E. & Neuhoff, K. & Spagnolo, G., 2005. "Agglomeration in Internet Co-operation Peering Agreements," Cambridge Working Papers in Economics 0505, Faculty of Economics, University of Cambridge.
    16. Spagnolo, Giancarlo & Blonski, Matthias, 2002. "Relational Contracts and Property Rights," CEPR Discussion Papers 3460, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    Market Interaction; Contract Enforcement; Incomplete Contract; Involuntary Unemployment; Repeated Transaction; Fairness Preferences;
    All these keywords.

    JEL classification:

    • D2 - Microeconomics - - Production and Organizations
    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • C9 - Mathematical and Quantitative Methods - - Design of Experiments

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