Frictions and the Persistence of Inferior Contract Terms
A rudimentary conceptualization of the development of ancillary contract terms would assert competition will result in terms that are joint-wealth-maximizing for merchants and customers. Building on developments in modeling frictions in markets, this article presents simple models of frictions in multi-period contracting as to ancillary contract terms. The modeling illustrates that, for plausible parameter estimates of frictions, combinations of switching costs and investigation costs may allow collectively inferior contract terms to persist in consumer transactions. The results are in harmony with recent evidence illustrating the infrequency with which consumers actually read contract terms.
The modeling identifies circumstances where this opportunistic behavior-- taking advantage of frictions to secure collectively suboptimal contract terms--is particularly likely. They include: (i) contracts of small dollar amounts, in terms of consideration or marginal cost in rendering performance; (ii) contracting involving the sequencing of relationship-specific investments during formation; (iii) multi-period contracting involving increasing switching costs; (iv) rapidly growing markets; and (v) merchants who bifurcate contractual terms among customers. A number of these factors are common to the provision of online services.
This article additionally samples authority that can be revived by courts inclined to police opportunistic structuring of the methods of mutual assent to secure collectively suboptimal contract terms.