Contracts, Norms, and Power I
Week 2 · September 9, 2026
Opening Hook
A supplier misses a delivery window by a few hours. The buyer could invoke the contract, threaten penalties, and search for a replacement. Instead, the buyer calls, asks what happened, and adjusts the next order. Nobody says the contract does not matter. But in many business relationships, the contract is not the only thing doing the work.
The same is true inside workplaces. A job description may be formal, but much of daily cooperation depends on expectations that are understood rather than written. People decide when to be flexible, when to insist, when to forgive, and when to escalate.
Here is the question this session is about: how do contracts, norms, and relationships govern economic exchange when not everything can be written down?
Ask students for examples of “understood” expectations in jobs, teams, clubs, or family businesses. Separate moral expectations from economic governance mechanisms: both matter, but they are analytically distinct.
Non-Contractual Relations
Macaulay’s classic reading asks us to notice that firms often do not behave as if every dispute should be converted immediately into legal enforcement. They use reputation, repeated dealings, informal adjustment, and shared commercial norms.
This is not because written contracts are irrelevant. It is because the written contract is only one part of the governance system. When uncertainty is high or performance is hard to verify, relational mechanisms can be faster and more informative than legal ones.
A contract can structure a relationship without fully governing every action inside it.
When would relying on informal trust be efficient, and when would it create opportunities for exploitation?
Monitoring and Verifiability
The readings on transaction costs and monitoring technologies point toward a central distinction: some things can be observed by the parties but not verified cheaply by a third party. A manager may know that a worker solved a problem creatively. A court may not be able to verify that claim without enormous cost.
This distinction helps explain why organizations use authority, ownership, and job design. If monitoring improves, the boundary between market exchange and employment may move. But better monitoring also changes power, discretion, and privacy.
Information technology can lower some transaction costs while creating new questions about control.
What is the difference between observing and verifying a worker's effort?
- There is no difference.
- Observation can be private to the parties; verification means proving it to an outside enforcer.
- Verification is always easier than observation.
- Digital monitoring makes all effort perfectly contractible.
Review Cards
Work through these cards now, then Orbit will schedule them for review.
Connections
Builds on: Session 1, where we introduced incomplete contracts as the organizing problem.
Sets up: Session 3, where we connect incomplete contracts to job matches, rents, and power.
Arc note: The point is not “formal bad, informal good.” The point is that formal and informal governance interact, and each changes who has discretion.
Reading Guide
Required
Bowles and Halliday. Microeconomics: Competition, Conflict, and Coordination, Chapter 10 sections 10.1-10.7. Canvas/library.
What to look for: How incomplete contracts create a need for institutions beyond spot-market exchange.
Macaulay, Stewart. “Non-Contractual Relations in Business.” Canvas/library.
What to look for: Examples of firms relying on norms, relationships, and adjustment rather than immediate legal enforcement.
Optional
Baker and Hubbard. Reading on monitoring technologies and asset ownership in trucking. Canvas/library.
Look for how better information changes job design and ownership.
Tadelis and Williamson. Reading on transaction cost economics. Canvas/library.
Use this as a bridge from contract incompleteness to governance structures.