Measurement Costs and the Market for Variable Quality Commodities

Yoram Barzel (University of Washington)
Aurora Stephany (University of Washington)

Abstract : Observing the characteristics of a good is at the root of any transaction. As pointed out by Barzel (1982) in his paper about measurement costs, the problem of measuring the attributes of a commodity is much more central to the economic problem than the widespread assumption of zero transaction costs would lead to believe. Measurement is always costly, and some resources will be dissipated, and possibly, mutually beneficial trade will be forgone in the absence of measurement information. In this paper, we develop a model in which a seller has a batch of goods of varying quality. Pricing each good individually is prohibitively expensive, so they are all sold at the same price. In the absence of trust between buyer and seller, the former doesn’t trust the latter with the selection of units, because the seller would gain by giving him the worst units in order to improve the remaining distribution. So the buyer will spend some resources “picking and choosing”, that is, inspecting items until finding an acceptable one. This inspection is costly and will result in trade below the optimal levels. We prove several results: 1., in such circumstances the good will be necessarily sold at a price above the average value, with buyers still participating in the market if they can inspect until they find items from the top of the distribution. 2. the distribution will decay over time, and the seller will be forced to lower the price. 3. The greater the dispersion in the quality of the goods, the larger the difference between average value and initial price, and the larger the dissipation associated with the lack of trust. 4., when there are different types of buyers, the ones with lower cost of inspecting (and with lower willingness to pay) will drive out the ones with higher inspection cost and higher ability to pay. When this problem is serious enough, the market for the commodity may not exist. Empirical tests for the implications of this model are still under development.

Contracts As Reference Points in Venture Capital

Richard Fairchild (University of Bath)
Maija Halonen-Akatwijuka (University of Bristol)
John Lewis (UPEC, IAE Gustave Eiffel and IRG)

Abstract : We apply contracts as reference points (Hart and Moore (2008) and Hart (2009)) in venture capital. We find that the venture capitalist, VC, chooses to leave some surplus for the entrepreneur, E, even when he has all ex ante bargaining power to guarantee a smoother ex post relationship. However, renegotiation can occur in equilibrium leading to souring of the relationship and deadweight losses. Therefore not all efficient projects will be funded. Contractual clauses such as vesting arrangements and noncompete clauses enable VC to lower the equity offer to E. Furthermore, VC benefits from costlier renegotiation as E will accept a lower equity share without triggering renegotiation.

Modeling Legal Modularity

Ted Sichelman (University of San Diego)
Henry Smith (Harvard University)

Abstract : Law employs modular structures to manage the complexity among legal actors. Property, torts, contracts, intellectual property, and doctrines in other areas of the law reduce information costs in similar ways by chopping up the world of interactions between parties into manageable chunks—modules—that are semi-autonomous. These modules employ boundaries—whether “real” boundaries as in real property law or “abstract” boundaries as in intellectual property, torts, and contracts—to hide information so as to make law less context-dependent and, hence, more modular. Previous explications of modularity in law have been qualitative. Here, borrowing from numerical measures of modularity in network theory, we offer the beginnings of a quantitative model of legal modularity. We posit that our “network science” approach to jurisprudential issues can be adapted to quantify many other important aspects of legal systems.