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On Reputation: A Microfoundation of Contract Enforcement and Price Rigidity

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  • Ernst Fehr
  • Martin Brown
  • Christian Zehnder

Abstract

We study the impact of reputational incentives in markets characterised 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 characterised by moral hazard, reputational incentives unambiguously increase mutually beneficial exchanges, reduce rents, and render markets more responsive to supply and demand shocks.

Suggested Citation

  • Ernst Fehr & Martin Brown & Christian Zehnder, 2009. "On Reputation: A Microfoundation of Contract Enforcement and Price Rigidity," Economic Journal, Royal Economic Society, vol. 119(536), pages 333-353, March.
    • Handle: RePEc:wly:econjl:v:119:y:2009:i:536:p:333-353
    DOI: 10.1111/j.1468-0297.2008.02240.x
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • 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 - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • C9 - Mathematical and Quantitative Methods - - Design of Experiments

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