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On Reputation: A Microfoundation of Contract Enforcement and Price Rigidity

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Author Info
Fehr, Ernst () (University of Zurich)
Brown, Martin () (Swiss National Bank)
Zehnder, Christian () (University of Zurich)

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Abstract

We study the impact of reputational incentives in markets characterized by moral hazard problems. Social preferences have been shown to enhance contract enforcement in these markets, while at the same time generating considerable wage and price rigidity. Reputation powerfully amplifies the positive effects of social preferences on contract enforcement by increasing contract efficiency substantially. This effect is, however, associated with a considerable bilateralisation of market interactions, suggesting that it may aggravate price rigidities. Surprisingly, reputation in fact weakens the wage and price rigidities arising from social preferences. Thus, in markets characterized by moral hazard, reputational incentives unambiguously increase mutually beneficial exchanges, reduce rents, and render markets more responsive to supply and demand shocks.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 3655.

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Date of creation: Aug 2008
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Handle: RePEc:iza:izadps:dp3655

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Related research
Keywords: wage rigidity price rigidity relational contracts reciprocity reputation

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
C9 - Mathematical and Quantitative Methods - - Design of Experiments

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