Question

Economists tend to ask two questions in a bilateral contracting situation: Is the outcome

efficient? How are the gains distributed?

(a). Suppose that landlords and tenants care only about the expected or average

gain from the contract, and not about risk. Comparing a sharecropping contract to a

fixed-rent contract: which of these is efficient? Briefly explain.

(b). Now suppose (realistically) that tenants lack assets and do not have access to

insurance or credit markets. They are therefore in a poor position to bear risk. Can this

help explain the persistence of sharecropping contracts? Briefly explain.

Answer key:

(a). Compare the economic surplus and employment level under the two contracts.

(b). Compare the expected rate of return for landlords and tenants under the two contracts in good state and bad state.

Answer 1

a) A fixed rent contract is more efficient as compared to a sharecropping contract. This is because in fixed rent the farmer owns a fixed amount to the landlord irrespective of the amount produced on the land. Hence the farmer is incentivised to produce maximum output so that he is left with the maximal amount after subtracting the fixed amount. In a sharecropping contract the farmer share a proportion of the output with the landlord. This disincentivises the farmer to produce the maximum output and hence leads to undersupply of labor. Hence expected return to landlord and tenant is maximum under fixed contract and also is the conomic surplus.

2) If the farmer had no capacity to bear risk then he would prefer the sharecropping because it provides insurance to the farmer that in case of a bad harvest he would have some part of the output left with him after paying the landlord. However in the case of fixed rent the farmer runs the risk of zero output after subtracting the fixed rent to be payed to the landlord. This explains the prevalance of sharecropping contracts.