The contract curve is a point where a transaction is no longer profitable for both parties. It is used to determine when to pursue a deal and when to move on. It applies to different financial scenarios, including investing and day-to-day purchases.
A contract curve is one of several economic curves used to illustrate the point at which the likelihood of buyers and sellers considering a transaction profitable is exceeded and there is no longer any motivation to continue pursuing the transaction. Considered part of Pareto efficient allocations, projecting this curve can help determine when there is still a compelling reason to pursue the transaction and when both parties should simply move on to other opportunities.
One of the easiest ways to understand the concept behind the contract curve is to consider a business deal between two entities known as Trader A and Trader B. The former has an interest in the goods offered by the latter and vice versa . As a result, the two parties will enter into negotiations to arrange some sort of exchange that will be mutually beneficial to both parties, attempting to come to terms on issues such as the number of units each party will purchase and the unit prices that apply to both groups. of goods.
Assuming that the two parties can reach an agreement or employment contract that allows each to make volume purchases at certain price levels for the period of one calendar year, the relationship is beneficial for both parties. Everyone gets some kind of benefit from the arrangement, in terms of selling goods and also buying goods that are considered desirable. Once the contract is completed, if Merchant A wants to reduce the volume purchased from Merchant B while maintaining the unit price associated with the previous volume commitment, it is likely that Merchant B will no longer consider the deal beneficial and cause him to seek a new deal with another operator. It is at this point that the contract curve in history between the two traders is reached and continuing to pursue the employment relationship becomes futile.
The general concept of the contract curve can be applied to different financial scenarios. With investing, both buyer and seller must find a price range for a number of shares that are mutually beneficial to both parties before the deal can be completed. If a price cannot be agreed upon, both parties can look for opportunities elsewhere. Even in terms of day-to-day purchases of goods and services, the price and volume of a transaction must represent an acceptable level of benefit to both buyer and seller, or the deal leaves at least one party unsatisfied. The only way to avoid getting into the contract curve is for both parties to identify enough benefits from doing business that the transaction makes sense and both will be happy with the outcome.
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