Contract Duration and the Costs of Market Transactions
83 Pages Posted: 8 Jan 2018 Last revised: 12 May 2020
Date Written: May 11, 2020
The optimal duration of a supply contract balances the costs of re-selecting a supplier against the costs of being matched to an inefficient supplier when the contract lasts too long. I develop a structural model of contract duration that captures this tradeoff and provide an empirical strategy for quantifying (unobserved) transaction costs. I estimate the model using federal supply contracts for a standardized product, where suppliers are selected by procurement auctions. The estimated transaction costs are substantially greater than consumer switching costs and a significant portion of total buyer costs. Counterfactuals illustrate the importance of accounting for the duration margin.
Keywords: Supply Contracts, Intermediate Goods, Switching Costs, Auctions
JEL Classification: D22, D44, H57, L13, L14
Suggested Citation: Suggested Citation