A Theory of Self-Enforcing Agreements

In a self-enforcing agreement each party decides unilaterally whether he is better off continuing or stopping his relation with the other parties. He stops if and only if the current gain from stopping exceeds the expected present value of his gains from continuing. No outside party intervenes to enforce the agreement, to determine whether there has been violations, to assess damages, and to impose penalties. The theory gives a solution of the Prisoners' Dilemma. Application of the theory to transactions between a buyer and a seller gives limits on the sequence of prices that induces repeated transactions. Applied to a group of sellers, the theory describes the conditions under which competition is more profitable than collusion.