INVESTMENTS, HOLDUP, AND THE FORM OF MARKET CONTRACTS

We analyze incomplete contracts to induce efficient investment. With e xogenous switching costs, fixed-price contracts are efficient, generat e some rigidity in prices, are renegotiated intermittently by possibly small amounts, and when inflation is positive, generate asymmetric re sponses to shocks, all consistent with evidence on prices and wages. W ith two-sided specific investments, efficiency requires prices to have sufficient escalator clauses to avoid renegotiation, as observed in m any long-term contracts. A third case, with one-sided specific investm ents, can generate ''take or pay'' contracts and explain why firms som etimes pay for specific investments that appear to benefit employees d irectly.