Procurement Contracts: Fixed Price vs. Cost Plus

39 Pages Posted: 22 Mar 1999

See all articles by Patrick Bajari

Patrick Bajari

University of Michigan at Ann Arbor - Department of Economics; National Bureau of Economic Research (NBER)

Steven Tadelis

University of California, Berkeley - Haas School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: March 15, 1999

Abstract

Economists have applied the methodology of information economics and contract theory (mechanism design) to problems in procurement and regulation. With the standard adverse selection and moral hazard components, the principal should offer a menu of incentive contracts from which the employed firm (agent) will select a contract that reveals its hidden information. In reality, such menus are not observed. Researchers in engineering management have also studied the costs and benefits of alternative contractual arrangements. In this literature, time to completion, project complexity, construction change orders, and risk management are the fundamental problems in the contracting environment. A central conclusion is that "cost-plus" contracts minimize total completion time, while "fixed-price" contracts minimize total project costs. We develop a parsimonious model that formalizes these results and shed new light on the procurement process.

JEL Classification: D23, L14, L22, L74

Suggested Citation

Bajari, Patrick and Tadelis, Steven, Procurement Contracts: Fixed Price vs. Cost Plus (March 15, 1999). Available at SSRN: https://ssrn.com/abstract=156470 or http://dx.doi.org/10.2139/ssrn.156470

Patrick Bajari

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States
734-763-5319 (Phone)

HOME PAGE: http://www-personal.umich.edu/~bajari/

National Bureau of Economic Research (NBER)

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Steven Tadelis (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

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United States

National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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United Kingdom

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