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Chapter 14 Bargaining COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Chapter 14 – Take Aways Bargaining can be modeled as either a simultaneous or sequential game. A player can gain an advantage by shifting a simultaneous-move game to a sequential-move game. Credible commitments are difficult to make because they require players to commit to a course of action against their self-interest. Thus, the best threat is one you never have to use.

Chapter 14 – Take Aways The strategic view of bargaining focuses on how the outcome of bargaining games depends on who moves first and who can commit to a bargaining position, as well as whether the other player can make a counteroffer. The nonstrategic view of bargaining does not focus on the explicit rules of the game to understand the likely outcome of the bargaining. This view focuses on the gains from bargaining relative to alternatives. The gains from bargaining relative to the alternatives to bargaining determine the terms of any bargain. Anything you can do to increase your opponent’s gains from reaching agreement or to decrease your own will improve your bargaining position.

Review of Chapter 13 Equilibria are likely outcomes of games  Learn to avoid bad equilibria Sequential games  First-mover advantage  Credible commitments Simultaneous games  Best response computation Prisoners’ dilemma  Tension between conflict and cooperation Repeated games  Be nice  Be forgiving  Be easily provoked  Don’t be envious  Be clear Other games

Introductory Anecdote Rhode Island Employee Pharmaceutical Benefits  Blue Cross/Blue Shield signed contract with PharmaCare to provide pharmaceutical benefits to Rhode Island state employees  PharmaCare assembled small network of providers  Excluded providers complained  Governor expressed support for freedom of choice  But, providing freedom of choice destroyed bargaining power to gain lower prices

Bargaining (Simultaneous Game) Management and labor are bargaining over a fixed sum of $200 million Two possible strategies available to each player: “bargain hard” or “accommodate”  If both bargain hard, no deal is reached  If both accommodate, then they split the gains from trade.  If one player bargains hard and the other accommodates, then the player who bargains hard takes 75% of the “pie”

Bargaining (Simultaneous Game) Two equilibria in this game  Management prefers the lower-left equilibrium  Labor prefers the upper-right. Game of “Chicken”

Bargaining Game: First Mover Advantage... Management “wins” by moving first and making a low offer

Bargaining Game: First Mover Advantage Union “wins” by credibly committing to strike if a low offer is made

A Nonstrategic View of Bargaining Outcome of bargaining “games” dependent on rules of the game; in real life, the rules are not always clear. John Nash proved that any reasonable outcome, z, would maximize the product of the bargainers’ surplus:  [S 1 (z) – D 1 ][(S 2 (z) – D 2 ], S i (z) is the value of reaching agreement z D i is “disagreement value,” or pay-off if no agreement is reached  The gains from bargaining relative to the alternatives to bargaining, determine the terms of any bargain  To increase your bargaining power, you increase your opponent’s surplus Or decrease your own  If your rival has more to gain by agreeing, he becomes “weaker”

Improving Bargaining Position Discussion Question: When is the best time to ask for a raise? Discussion Question: When is the best time to buy a car? Discussion Question: How can mergers or acquisitions improve bargaining power?

Merger Bargaining Example Managed care plan markets its network to an employer  Price is $100 if it contains either of two merging hospitals  Price is $120 if it contains both  No sale without one of the hospitals Gain to the managed care plan from adding either of the hospitals to its network when it already has the other is $20  Nash bargaining solution predicts is evenly split  Each hospital gets $10 for joining the managed care network Now suppose the hospitals merge and bargain together  The managed care plan can no longer drop one of the hospitals, so the gain from striking a bargain with the merged hospital is the full $120  Gain is evenly split in the Nash bargaining solution  The merged hospitals thus receive $60, while the separate merging hospitals received only $20

Alternate Intro Anecdote Under the 2002 CHAOS (Create Havoc Around Our System) plan, flight attendants threatened to either stage a mass walkout for several days or to strike individual flights of Midwest Express, with no advance warning to either customers or management. Midwest Express reaction  Cancelled all flight attendant vacations  Threatened to lock out any employee who participated in the strike effort Flight attendant union promised funding from its strike fund to support any attendant who ended up locked out. The biggest strength of the union’s threat was that it could be effective without full implementation.  The mere threat of random strikes was enough to push passengers to other airlines. Within 30 days of announcing implementation of CHAOS, the union successfully negotiated a new contract.