Advances in New Institutional Analysis series
Edited by Claude Ménard and Michel Ghertman
Chapter 4: Incentives and Transaction Costs in Public Procurement
Steven Tadelis INTRODUCTION Standardized goods, such as computers, office supplies and automobiles are mass produced, have standard characteristics and are typically purchased at list price from a menu of prespecified characteristics. Custom made goods, such as new buildings, custom-software or legal services are tailored to fit a buyer’s specific and often unique needs. To procure these customized goods, the buyer usually hires a contractor who supplies the good or service according to a set of desired specifications, referred to as the procurement problem. The procurement problem has attracted much attention both in policy and in academic circles. The main focus of academic economists has been on procurement by the public sector, in part because of its sheer importance to the economy. For example, procurement by federal, state and local government accounts for more than 10 percent of gross domestic product in the United States. When considering the procurement of goods and services, the buyer is faced with many challenges. First, she has to choose what exactly should be procured, and how to transmit her needs to the potential suppliers. Second, a contract must be laid out that includes contractual obligations and methods of compensation. Third, the buyer needs to decide how to award the procurement contract between the potential suppliers. Finally, the award mechanism should result in the selection of a qualified and desirable supplier and in the implementation of a cost-effective final product. Procurement is often achieved with the buyer seeking, through competitive bidding, a low price to purchase...
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