"Long-Term Contracting with Markovian Consumers

To study how a firm can capitalize on a long-term customer relationship, we characterize the optimal contract between a monopolist and a consumer whose preferences follow a Markov process. The optimal contract is non-stationary and has infinite memory, but is described by a simple state variable. Under general conditions, supply converges to the efficient level for any degree of types' persistence and along any history, though convergence is history-dependent. In contrast as with constant types, the optimal contract can be renegotiation-proof, even with highly persistent types. These properties provide insights into the optimal ownership structure of the production technology.

Keywords: contract theory, price discrimination, adverse selection, ownership rights. 
JEL Classification: D42, D82, D23.

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