Question

Describe the hold-up problem and why it is a problem.

Answer 1

In economics, hold-up problem or commit problem refers to a problem in which optimum efficiency can be achieved when two parties cooperate, however, the parties refrain from cooperating because of the apprehension that doing so can give a higher level of bargaining power to the other party and diminish their own profit. For example, if party X makes a prior commitment to party Y, party Y can use this commitment to gain a higher bargaining power at the cost of party X's profitability. Therefore, party X suffers.

Hold up problem is a problem because it leads to under-commitment which leads to underinvestment, incomplete contracts, and loss of economic efficiency. Also, hold up problem leads to high economic costs.