lecture 2 contracts

Question 1

What are classical contracts? What is an example of this?

Answer 1

Legally enforcable contract that specifies terms of exchange. Long-term and often with finite length. Eg commerical lease

Question 2

Why are classical contracts so important for firms?
what are the 2 reasons for this

Answer 2

1)Uncertainty is costly to
Changing input prices and suppliers
Gives certainty about workers

2) Prevents opportunism (cheating), try and change the terms because you learn something new
-Downstream buyers not paying
-Suppliers selling lower quality goods
-‘Hold up’ , changing price

Question 3

What are relational contracts?
what is an example of this?

Answer 3

Unwritten codes of conduct which are sustained by the prospect of future relationships

• Boss employee relationship

Question 4

What are the three core contracts?

Answer 4

spot contract
classical contract
Relational contract

Question 5

What are firm examples of relational contracts?

Answer 5

Discretionary bonuses / promotions

• usually on the basis of qualitatively assessed bonus
  -Can be based on tasks not anticipated/ indluded in classical contract
  -Contigent on company performance

Question 6

Are relational contracts really contracts?

Answer 6

Economists analyse them as a real contract

Question 7

What type of contract is employment

Answer 7

classical / relational

Question 8

what type of contract is a restuarant

Answer 8

spot/ relational

Question 9

What type of contract is electrical goods with guarantee

Answer 9

Spot/classical

Question 10

What are the pros and cons of spot contracts?

Answer 10

Pros
Low transaction costs - no lawyers needed]
easily and widely implementable

Cons
Can lead to short term-opportunism
No incenvtive to invest as you are selling at market prices
Uncertainty as exposure to market prices can cause volatiltiy

Question 11

What are the pros and cons of relational contracts

Answer 11

Pros
Can incentivise non-contractbile outcomes
Does not require legal enforcement
Flexible - now you can do something radically different

Cons
Cannot always be applied - only to long term relationship
Open to abusive power as someone must have the power
Exposed to culutral misunderstandings

Question 12

What is a limitation of classical contract?

Answer 12

-Does not prepare/ cover every eventuality

Question 13

What are the solutions to coordination problems?

Answer 13

-Commitment
-Authority
-Delegation
-Convention
-Repuation