BUYER GROUPS

When does it pay a coalition of buyers and a coalition of sellers to b y-pass a non-cooperative market outcome by negotiating an alternative contract? Should these collective contracts be allowed? This paper inv estigates one source of the incentive for collective contracting: the failure of monopolistically competitive markets to achieve the optimal trade-off between lower costs and greater variety or availability of products. A collective contract benefits buyers inside the coalition b ut imposes a negative externality on buyers outside the coalition, who face higher prices and lower availability when the contract is allowe d. We analyze the conditions under which the collective contracts incr ease total welfare. We suggest that the model represents one component of the incentives for ''managed competition'' in health care markets.