Chapter 11 Vertical contractual relations

Abstract

This chapter discusses the contractual relationship between two parties at successive stages in the vertical chain of production and marketing for a good. Intermediate good markets differ from final good markets, and thus merit independent study. First, intermediate good markets often involve large transactions made by sophisticated buyers. Second, the products being sold may possess very complex bundles of attributes, making problems of moral hazard more severe or at least more complicated. Third, the buyers' demands for an intermediate good are interdependent when the buyers are product–market competitors with one another. Fourth, the buyers of an intermediate good typically are involved in a game in the downstream product market, and the sales contract for the upstream product may affect the equilibrium of this downstream game. The buyers of intermediate goods often can credibly threaten to integrate backward into supply of the intermediate good. Given the sophistication of buyers and the large scale of individual transactions, complex selling schemes may be practicable intermediate good markets. Sellers may utilize sophisticated pricing mechanisms or nonprice contractual provisions. The chapter describes the private and social incentives to utilize such contracts.