Benjamin Klein

Vertical Integration, Appropriable Rents, and the Competitive Contracting Process

The potential of post-contractural apportunistic behavior for improving market efficiency through intrafirm rather than interfirm transactions is examined under the assumption that vertical costs will increase less than contracting costs as specialized assets and appropriable quasi rents increase. Vertical integration protects against the risk of contract cancellation and can create market power which is not generally referred to as monopoly. Contracts used as a alternative provide economically enforceable protection against opportunistic behavior. Solutions to opportunistic behavior problems can include joint ownership of common assets and condominium ownership of services. Economies of scale are major factors in some businesses, such as insurance. The complexities of ownership relations makes it difficult to assign higher costs to either the contract or vertical-integration approach. This suggests that economic analysis should be used to identify which is most advantageous for specific kinds of activities.

The Role of Market Forces in Assuring Contractual Performance

The conditions under which transactors can use the market (repeat-purchase) mechanism of contract enforcement are examined. Increased price is shown to be a means of assuring contractual performance. A necessary and sufficient condition for performance is the existence of price sufficiently above salvageable production costs so that the nonperforming firm loses a discounted steam of rents on future sales which is greater than the wealth increase from nonperformance. This will generally imply a market price greater than the perfectly competitive price and rationalize investments in firm-specific assets. Advertising investments thereby become a positive indicator of likely performance.

The Selection of Disputes for Litigation

THIS paper addresses the relationship between litigated disputes and disputes settled before or during litigation. The specification of this relationship is important for the analysis both of the legal system and of the influence of the legal system on society. Virtually all systematic knowledge of the legal system derives from studies of appellate cases. Appellate cases, of course, provide the most direct view of doctrinal developments in the law. Few scholars today, however, are content to study doctrinal developments alone without regard to the broader influence of legal rules on social affairs. Appellate cases may tell us which disputes courts find troublesome and which they find easy to decide. But this doctrinal information discloses very little about how legal rules affect the behavior of those subject to them or affect the generation of legal disputes themselves. If all legal disputes, or even a random sample of these disputes, were tried to judgment and then appealed, the inference from legal rules to social behavior would be straightforward. The facts of appellate cases

Vertical Restraints as Contract Enforcement Mechanisms

IT is now generally recognized that there are many cases of vertical restraints that do not fit the standard consumer free riding on special services theory.1 For example, the widespread use of resale price maintenance in the marketing of brand name clothing cannot be explained as inducing retailers to supply services such as dressing rooms. It is unlikely that consumers must be prevented from trying on clothing free of charge at a full-service retailer before purchasing the clothing at a discount from retailers who do not supply dressing rooms. A number of authors recently have attempted to correct this deficiency in the standard theory by expanding the type of services that vertical restraints may induce retailers to supply and the corresponding retailer free-riding problems.2 The standard economic analysis of how vertical restraints operate to induce desired retailer behavior has remained essentially unchanged, however. The standard analysis assumes that when it is not feasible for a manufacturer to write explicit, court-enforceable contracts with retailers for the supply of particular services, the only alternative mechanism manufacturers can use to induce the supply of desired services is to increase the direct return retailers receive from consumers when those

The Competitive Supply of Money

FEW AREAS OF ECONOMIC AcTIvrrY can claim as long and unanimous a record of agreement on the appropriateness of governmental intervention as the supply of money.l Very early in our history money was recognized by policy makers to be special, and individuals fearful of government influence in other areas of economic life readily acknowledged that government had a primary role in controlling monetary arrangements. Free market advocates who now argue for, among other things, unregulated entry and the elimination of all interest rate and portfolio restrictions do not opt for a completely unregulated money industry, but recognize that money has unique characteristics which require that it not be supplied freely as an ordinary good. The monetary role of government is agreed to include, at a minimum, the monopolistic supply of a currency, into which all privately supplied demand deposits should be convertible. In

On a Correct Measure of Inflation

Two commonly cited and newsworthy price indices are the Bureau of Labor Statistics Consumer Price Index and the Commerce Departments GNP deflator. These indices have become an important part of our economic intelligence and are frequently considered to be the operational counterparts of what economists call the price level. They, therefore, often are used as measures of inflation and often are targets or indicators of monetary and fiscal policy. Nevertheless, these price indices, which represent measures of current consumption service prices and current output prices, are theoretically inappropriate for the purpose to which they are generally put. The analysis in this paper bases a price index on the Fisherian tradition of a proper definition of intertemporal consumption and leads to the conclusion that a price index used to measure inflation must include asset prices. A correct measure of changes in the nominal money cost of a giverl utility level is a price index for wealth. If monetary impulses are transmitted to the real sector of the economy by producing transient changes in the relative prices of service flows and assets (i.e., by producing short-run changes in the real rate of interest), then the commonly used, incomplete, current flow price indices provide biased short-run measures of changes in the purchasing power of money. The inappropriate indices that dominate popular and professional literature and analyses

The Economics of Block Booking

BLOCK booking involves the practice of licensing, or offering for license, one feature or group of features on the condition that the exhibitor will also license another feature or group of features released by distributors during a given period. This contractual arrangement, common in the American motion picture industry from as early as 1916,2 was declared illegal in two Supreme Court decisions, Paramount Pictures,3 where blocks of films were rented for theatrical exhibition, and Loews,4 where blocks of films were rented for television exhibition. The primary legal objection to block booking is that the practice extends monopoly power. In Paramount the Supreme Court stated that block booking adds to the monopoly of a single copyrighted picture that of another copyrighted picture.5 Similarly, in Loews, the Court asserted that a distributor cannot use the market power granted by the copyright in a desirable film to force exhibitors to license a second undesirable film, stating that the antitrust laws do not permit a compounding of

The Economics of Franchise Contracts

An incentive problem exists in franchise relationships because of the failure of franchisees to take account of franchisor profit. Franchise contracts ameliorate this malincentive not by specifying a proxy for desired franchisee performance, but by creating a premium stream that facilitates a self-enforcing agreement. The structure of credible commitments within this self-enforcing arrangement is elucidated, with initial franchisee investments shown to serve no performance guaranteeing purpose. Franchisors do not demand large initial lump sum payments from franchisees because doing so makes it more difficult to terminate franchisees for nonperformance. Franchisors use vertical integration when the premium necessary to assure franchisee performance is large.

Governmental Regulation of Cigarette Health Information

Governmental Regulation of Cigarette Health Information Author(s): Lynne Schneider, Benjamin Klein and Kevin M. Murphy Source: Journal of Law and Economics, Vol. 24, No. 3, Consumer Protection Regulation: A Conference Sponsored by the Center for the Study of the Economy and the State (Dec., 1981), pp. 575-612 Published by: The University of Chicago Press for The Booth School of Business of the University of Chicago and The University of Chicago Law School Stable URL: http://www.jstor.org/stable/725279 . Accessed: 05/03/2014 18:46

The Law and Economics of Franchise Tying Contracts

THIS paper analyzes from an economic perspective current antitrust law with regard to franchising requirements contracts, where a franchisee must purchase an input from the franchisor or from a particular supplier designated by the franchisor. The law takes an extremely hostile view toward such tie-in contracts, at least on the surface, by stating that tying is a per se offense. The Court has said that such contractual arrangements generally serve hardly any purpose beyond the suppression of competition2 and has held it not necessary to demonstrate anticompetitive effect before declaring them illegal. The per se standard under which tying arrangements are analyzed is unusual because of the essential role of economic analysis. To prove the existence of a per se illegal tying arrangement, one must demonstrate economically that three conditions are met: first, that two separate products exist; second, that there is sufficient market power in the tying good; and third, that a not insubstantial amount of commerce in the tied good market is affected.3 In addition, the per se standard permits affirmative defenses, such as the use of tying for quality control, and these also often entail sophisticated economic analysis. As Justice OConnor correctly