Contract failure

Last updated February 13, 2023

Contract failure describes a situation in which the consumer of a good or service is unable to evaluate its quality, thus incentivizing the producer to produce a lower quality good or service.^[1] Such behavior creates suboptimal economic conditions.^[2] Contract failure is one explanation for the existence of non-profit organizations,^[3]^[4]^[5] although even non-profits can fall victim to contract failure in the right situations. Contract failure is connected to, but distinct from, market failure

Information Asymmetry

The known cause of contract failure is called information asymmetry; when one party (the producer) has more information than the other party (the consumer) about a product or service.^[9] There is information inequality between the two parties.^[10] According to Young, there are three causes in which situations dealing with asymmetric information arise from, to include the following, 1) the quality of a product or service is too complex to be judged such as medical care or higher education; 2) the end consumer of the product or service cannot evaluate it him or herself such as a child in daycare or an elderly individual in a nursing home; and 3) the product or service is not consumed by the individual who purchased it, therefore the purchaser would never know if the producer delivered what was promised.^[9]

Nonprofit Existence

When contract failure occurs, there is a suboptimal provision of public goods, which results in market failure.^[11] Arrow argues that nonprofits will step in and provide the necessary good or service in response to market failure.^[10] When markets potentially take advantage of the information asymmetry situation, nonprofits must protect the consumer.^[12]

Non-Distribution Constraint

According to Hansmann, the “non-distribution constraint - prohibits the distribution of residual earnings to individuals who exercise control over the firm”.^[13] It prohibits those who have a vested interest in the organization from receiving the organization’s profit for personal gain. This constraint is a common characteristic of nonprofits, which creates less of a need for the company to take advantage of the consumer’s lack of knowing about such incidents. The nonprofit has no reason to cheat the consumer out of quality or service delivery because the organization's individuals cannot benefit in a direct manner. Therefore, the consumer is more likely to trust a nonprofit organization providing services than to trust a for-profit organization because of the nonprofit’s non-distribution constraint.^[9] According to Easley and O'Hara, state law stipulates that the organizations day-to-day costs should be reasonable.^[14]

Related Research Articles

A consumer is a person or a group who intends to order, or uses purchased goods, products, or services primarily for personal, social, family, household and similar needs, who is not directly related to entrepreneurial or business activities. The term most commonly refers to a person who purchases goods and services for personal use.

Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics focuses on the study of individual markets, sectors, or industries as opposed to the national economy as whole, which is studied in macroeconomics.

In economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfil all the necessary conditions of a perfectly competitive market. Imperfect competition will cause market inefficiency when it happens, resulting in market failure. Imperfect competition is a term usually used to describe the seller's position, meaning that the level of competition between sellers falls far short of the level of competition in the market under ideal conditions.

A non-governmental organization (NGO) or non-governmental organisation is an organization that generally is formed independent from government. They are typically nonprofit entities, and many of them are active in humanitarianism or the social sciences; they can also include clubs and associations that provide services to their members and others. Surveys indicate that NGOs have a high degree of public trust, which can make them a useful proxy for the concerns of society and stakeholders. However, NGOs can also be lobby groups for corporations, such as the World Economic Forum. NGOs are distinguished from international and intergovernmental organizations (IOs) in that the latter are more directly involved with sovereign states and their governments.

In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient – that can be improved upon from the societal point of view. The first known use of the term by economists was in 1958, but the concept has been traced back to the Victorian philosopher Henry Sidgwick. Market failures are often associated with public goods, time-inconsistent preferences, information asymmetries, non-competitive markets, principal–agent problems, or externalities.

A nonprofit organization (NPO) or non-profit organisation, also known as a non-business entity, not-for-profit organization, or nonprofit institution, is a legal entity organized and operated for a collective, public or social benefit, in contrary with an entity that operates as a business aiming to generate a profit for its owners. A nonprofit is subject to the non-distribution constraint: any revenues that exceed expenses must be committed to the organization's purpose, not taken by private parties. An array of organizations are nonprofit, including some political organizations, schools, business associations, churches, social clubs, and consumer cooperatives. Nonprofit entities may seek approval from governments to be tax-exempt, and some may also qualify to receive tax-deductible contributions, but an entity may incorporate as a nonprofit entity without securing tax-exempt status.

Collusion is a deceitful agreement or secret cooperation between two or more parties to limit open competition by deceiving, misleading or defrauding others of their legal right. Collusion is not always considered illegal. It can be used to attain objectives forbidden by law; for example, by defrauding or gaining an unfair market advantage. It is an agreement among firms or individuals to divide a market, set prices, limit production or limit opportunities. It can involve "unions, wage fixing, kickbacks, or misrepresenting the independence of the relationship between the colluding parties". In legal terms, all acts effected by collusion are considered void.

In economics, a public good is a good that is both non-excludable and non-rivalrous. For such goods, users cannot be barred from accessing or using them for failing to pay for them. Also, use by one person neither prevents access of other people nor does it reduce availability to others. Therefore, the good can be used simultaneously by more than one person. This is in contrast to a common good, such as wild fish stocks in the ocean, which is non-excludable but rivalrous to a certain degree. If too many fish were harvested, the stocks would deplete, limiting the access of fish for others. A public good must be valuable to more than one user, otherwise, the fact that it can be used simultaneously by more than one person would be economically irrelevant.

A price is the quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the commercial exchange, the payment for this product will likely be called its "price". However, if the product is "service", there will be other possible names for this product's name. For example, the graph on the bottom will show some situations A good's price is influenced by production costs, supply of the desired item, and demand for the product. A price may be determined by a monopolist or may be imposed on the firm by market conditions.

In sales, commerce, and economics, a customer is the recipient of a good, service, product or an idea - obtained from a seller, vendor, or supplier via a financial transaction or exchange for money or some other valuable consideration.

In contract theory and economics, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other.

The voluntary sector, independent sector, or civic sector is the realm of social activity undertaken by organizations that are non-governmental nonprofit organizations. This sector is also called the third sector, community sector, and nonprofit sector, in contrast to the public sector and the private sector. Civic sector or social sector are other terms for the sector, emphasizing its relationship to civil society. Richard Cornuelle coined the term "independent sector" and was one of the first scholars to point out the vast impact and unique mechanisms of this sector. Given the diversity of organizations that comprise the sector, Peter Frumkin prefers "non-profit and voluntary sector".

Information economics or the economics of information is the branch of microeconomics that studies how information and information systems affect an economy and economic decisions.

Goods are items that are usually tangible, such as pens, physical books, salt, apples, and hats. Services are activities provided by other people, who include architects, suppliers, contractors, technologists, teachers, doctors, lawn care workers, dentists, barbers, waiters, online servers, a digital book, a digital video game or a digital movie. Taken together, it is the production, distribution, and consumption of goods and services which underpins all economic activity and trade. According to economic theory, consumption of goods and services is assumed to provide utility (satisfaction) to the consumer or end-user, although businesses also consume goods and services in the course of producing other goods and services.

The social economy is formed by a rich diversity of enterprises and organisations, such as cooperatives, mutuals, associations, foundations, social enterprises and paritarian institutions, sharing common values and features:

Regulatory economics is the economics of regulation. It is the application of law by government or regulatory agencies for various purposes, including remedying market failure, protecting the environment and economic management.

In economics, profit is the difference between the revenue that an economic entity has received from its outputs and the total cost of its inputs. It is equal to total revenue minus total cost, including both explicit and implicit costs.

Helmut K. Anheier is a German-American academic. He is professor of sociology and past president of the Hertie School in Berlin. Until September 2019 he held a chair at the Max Weber Institute of Sociology, Heidelberg University, where he was also the Academic Director of the Center for Social Investment and Innovation. His research interests include civil society, social innovation, organizational theory, governance and policy research, social science methodology, including indicator models

This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.

Henry B. Hansmann is an American scholar of law and economics; he is the Oscar M. Ruebhausen Professor Emeritus of Law at Yale Law School.

References

↑ Walter Powell (W.); Richard Steinberg (2006). The nonprofit sector: a research handbook. Yale University Press. p. 121. ISBN 978-0-300-10903-0 . Retrieved 29 April 2013.
↑ Peter Benson (5 February 2001). The Theory of Contract Law: New Essays. Cambridge University Press. p. 54. ISBN 978-0-521-64038-1 . Retrieved 29 April 2013.
↑ Helmut K. Anheier (17 June 2004). A Dictionary of Civil Society, Philanthropy and the Third Sector. Taylor & Francis. p. 65. ISBN 978-0-203-40337-2 . Retrieved 29 April 2013.
↑ Robert D. Herman & Associates (31 January 2011). The Jossey-Bass Handbook of Nonprofit Leadership and Management. John Wiley & Sons. p. 211. ISBN 978-1-118-04658-6 . Retrieved 29 April 2013.
↑ Jyh-An Lee (2012). Non-Profit Organizations and the Intellectual Commons. Edward Elgar Publishing. p. 106. ISBN 978-1-78100-158-5 . Retrieved 29 April 2013.
↑ Stephen P. Osborne (2002). Public Management: Critical Perspectives. Taylor & Francis. p. 172. ISBN 978-0-415-23382-8 . Retrieved 29 April 2013.
↑ Debra King; Gabrielle Meagher (2009). Paid Care in Australia: Politics, Profits, Practices. Sydney University Press. pp. 64–67. ISBN 978-1-920899-29-5 . Retrieved 29 April 2013.
↑ Helmut K. Anheier; Wolfgang Seibel (1990). The Third Sector: Comparative Studies of Nonprofit Organizations. Walter de Gruyter. p. 65. ISBN 978-0-89925-486-9 . Retrieved 29 April 2013.
1 2 3 Young, D (1998). Contract Failure. In The Nature of the Nonprofit Sector (2nd ed.). Philadelphia: West View. pp. 154–157.
1 2 Arrow, J.K. (1963). "Uncertainty and the welfare economics of medical care". The American Economic Review: 941–973.
↑ Weisbrod, B.A. (1979). "Economics of Institutional Choice". Working Paper.
↑ Ihlan, H. (2013). "Nonprofit Organizations as Providers of Public Goods". Journal of Management & Economics. 20 (1): 95–104.
↑ Hansmann, H.B. (1980). "The Role of Nonprofit Enterprise". The Yale Law Journal. 5: 835. doi:10.2307/796089. JSTOR 796089.
↑ Easley, D.; O'Hara, M. (1983). "The Economic Role of the Nonprofit Firm". The Bell Journal of Economics: 531–538. doi:10.2307/3003654. JSTOR 3003654.

This business-related article is a stub. You can help Wikipedia by expanding it.

This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.

[(W.)Steinberg2006-1] Walter Powell (W.); Richard Steinberg (2006). The nonprofit sector: a research handbook. Yale University Press. p. 121. ISBN 978-0-300-10903-0 . Retrieved 29 April 2013.

[Benson2001-2] Peter Benson (5 February 2001). The Theory of Contract Law: New Essays. Cambridge University Press. p. 54. ISBN 978-0-521-64038-1 . Retrieved 29 April 2013.

[Anheier2004-3] Helmut K. Anheier (17 June 2004). A Dictionary of Civil Society, Philanthropy and the Third Sector. Taylor & Francis. p. 65. ISBN 978-0-203-40337-2 . Retrieved 29 April 2013.

[Associates2011-4] Robert D. Herman & Associates (31 January 2011). The Jossey-Bass Handbook of Nonprofit Leadership and Management. John Wiley & Sons. p. 211. ISBN 978-1-118-04658-6 . Retrieved 29 April 2013.

[Lee2012-5] Jyh-An Lee (2012). Non-Profit Organizations and the Intellectual Commons. Edward Elgar Publishing. p. 106. ISBN 978-1-78100-158-5 . Retrieved 29 April 2013.

[Osborne2002-6] Stephen P. Osborne (2002). Public Management: Critical Perspectives. Taylor & Francis. p. 172. ISBN 978-0-415-23382-8 . Retrieved 29 April 2013.

[KingMeagher2009-7] Debra King; Gabrielle Meagher (2009). Paid Care in Australia: Politics, Profits, Practices. Sydney University Press. pp. 64–67. ISBN 978-1-920899-29-5 . Retrieved 29 April 2013.

[AnheierSeibel1990-8] Helmut K. Anheier; Wolfgang Seibel (1990). The Third Sector: Comparative Studies of Nonprofit Organizations. Walter de Gruyter. p. 65. ISBN 978-0-89925-486-9 . Retrieved 29 April 2013.

[Young-9] 1 2 3 Young, D (1998). Contract Failure. In The Nature of the Nonprofit Sector (2nd ed.). Philadelphia: West View. pp. 154–157.

[Arrow-10] 1 2 Arrow, J.K. (1963). "Uncertainty and the welfare economics of medical care". The American Economic Review: 941–973.

[11] Weisbrod, B.A. (1979). "Economics of Institutional Choice". Working Paper.

[ihlan-12] Ihlan, H. (2013). "Nonprofit Organizations as Providers of Public Goods". Journal of Management & Economics. 20 (1): 95–104.

[13] Hansmann, H.B. (1980). "The Role of Nonprofit Enterprise". The Yale Law Journal. 5: 835. doi:10.2307/796089. JSTOR 796089.

[14] Easley, D.; O'Hara, M. (1983). "The Economic Role of the Nonprofit Firm". The Bell Journal of Economics: 531–538. doi:10.2307/3003654. JSTOR 3003654.

[1]

[2]

[3]

[4]

[5]

[6]

[7]

[8]

[9]

[10]

[11]

[12]

[13]

[14]