one decides what and how much to buy. As such, there is an absence of product precedent and competition, and therefore, no basis by which to set prices. (It may be argued, however, that within the government market there is inter-agency and inter-service competition for contracted services and products that creates an environment that is more like the free market than a single buyer market.) Prices are thus determined after cost estimates and inflation, and include the profit margin that has been designated by the government.
This profit margin is determined by the government's policy of "cost plus fixed fee" contracts. In such a system, for instance, a contractor could bid $1 million dollars for a given job, and expect to receive $70,000 in profits. However, if actual costs go beyond the original bid -- something that happens all too frequently -- the government can review the program and allow overrun funds to cover the deficiency. Even so, the profit margin will remain at 7% of the original bid, and thus the contractor will receive less than 7% of the actual total costs. On the other hand, if the work is completed for less than the bid amount, the contractor must return the unused portion of the bid amount, but retains the fixed fee, which increases the profit margin. Unfortunately, cost under runs are exceptionally rare, and cost overruns are exceptionally common.
In recent years, the government has been phasing out the "cost plus fixed fee" contract in favor of those that carry incentive payments based on performance (Wilson, 1983). Many variations of such arrangements a
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