Role of Market Forces in Assuring Contractual Performance, The

Competition Policy and Antitrust and Networks, the Internet, and Cloud Computing

Article Snapshot

Author(s)

Benjamin Klein and Keith B. Leffler

Source

The Journal of Political Economy, Vol. 89, No. 4, 1981

Summary

This classic paper shows how market forces can help enforce contracts.

Policy Relevance

Consumers willingness to stop buying low quality products when quality matters to them discourages firms from lowering quality. Market forces discourage cheating without regulation enforcement.

Main Points

  • Firms will sell a stream of high quality products continuously, rather than cheat by switching from high to low quality products, so long as they profit more from doing so.

  • Firms will reap higher profits from a continuous high-quality stream of products when consumers buy the high quality product repeatedly, but stop buying the low quality product.
    • Consumers must prefer paying more for better goods than paying less for lower quality.

  • Firms can make more selling a stream of quality products only if the price holds high enough over non-recoverable costs. Competitors are likely to enter to undercut the price.

  • The need to invest in non-recoverable costs will deter some price-cutting entry. The investment can be investment in brand names or production capital.

  • Consumers can use the threat of not buying again to discourage firms from lowering quality. Consumers might want to know whether higher prices are due to high costs or to premium pricing. Advertising can assure consumers the firm will sell quality goods in the long run.

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