Long Term Contracts, Arbitrage, and Vertical Restraints

The paper argues that sellers sometimes impose exclusivity clauses on their buyers in order to prevent arbitrage between brands. In a duopoly model in which the sellers compete through fairly general long term contracts, it is shown that common agency is always allowed whenever reselling can be controlled directly, but that exclusive dealing is imposed otherwise. The model also offers a new rationale for ex post inefficient penalties for breach of contract. Equilibrium long term contracts are shown to reduce sellers'profits and to increase the buyers'surplus relative to the spot market level. exclusive dealing lowers overall welfare in this model. As an illustraiton, the theory is applied to the case of British brewers.