Flexible contracting theory and case examples

When companies or governmental agencies arrange for contracts that call for deliveries over extended periods of time, arrangements are often made to adjust the final prices for exogenous changes in the costs of production. This paper shows, under specified conditions, how contracts can be devised which allow for price changes but at the same time still provide incentives for the producing unit to be efficient. For example, only under very specific conditions will a “pass-through” arrangement be acceptable. We show how the techniques of Geometric Programming applied to the economic theory of production can be used to analyze such problems.