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American Economic Review: Vol. 99 No. 4 (September 2009)

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Expectation Damages, Divisible Contracts, and Bilateral Investment

Article Citation

Ohlendorf, Susanne. 2009. "Expectation Damages, Divisible Contracts, and Bilateral Investment." American Economic Review, 99(4): 1608-18.

DOI: 10.1257/aer.99.4.1608

Abstract

This paper examines the efficiency of expectation damages as a breach remedy in a bilateral trade setting with renegotiation and relationship-specific investment by the buyer and the seller. As demonstrated by Edlin and Reichelstein (1996), no contract that specifies only a fixed quantity and a fixed per-unit price can induce efficient investment if marginal cost is constant and deterministic. We show that this result does not extend to more general payoff functions. If both parties face the risk of breaching, the first best becomes attainable with a simple price-quantity contract. (JEL D86, K12)

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Authors

Ohlendorf, Susanne (U Bonn)

JEL Classifications

D86: Economics of Contract: Theory
K12: Contract Law


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