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Long-Term Contracting with Markovian Consumers

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  • Marco Battaglini

Abstract

To study how a firm can capitalize on a long-term customer relationship, we characterize the optimal contract between a monopolist and a consumer whose preferences follow a Markov process. The optimal contract is nonstationary and has infinite memory, but is described by a simple state variable. Under general conditions, supply converges to the efficient level for any degree of persistence of the types and along any history, though convergence is history-dependent. In contrast, as with constant types, the optimal contract can be renegotiation-proof, even with highly persistent types. These properties provide insights into the optimal ownership structure of the production technology.

Suggested Citation

  • Marco Battaglini, 2005. "Long-Term Contracting with Markovian Consumers," American Economic Review, American Economic Association, vol. 95(3), pages 637-658, June.
  • Handle: RePEc:aea:aecrev:v:95:y:2005:i:3:p:637-658
    Note: DOI: 10.1257/0002828054201369
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