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Bargaining and Search with Recall: A Two-Period Model with Complete Information Author(s): Ching Chyi Lee

Source: Operations Research, Vol. 42, No. 6 (Nov. - Dec., 1994), pp. 1100-1109 Published by: INFORMS Stable URL: http://www.jstor.org/stable/171988 . Accessed: 21/11/2013 15:45
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) There is a long list of incomplete information bargaining models that try to make this point clear (see. and. bargainers with "better" reservation prices tend to get better outcomes. Area of review: DECISIONANALYsIs.AND SEARCH WITH RECALL:A TWO-PERIOD BARGAINING MODELWITHCOMPLETEINFORMATION CHINGCHYILEE The Chinese University of Hong Kong.44 on Thu.. the discount factor and bargaining cost in Rubinstein). Grossman and Perry 1986. quite contrary to the standard results of previous complete information bargaining models that complete informationrenders no guarantee for immediate resolution of bargaining. and Binmore. Shatin. and Chatterjee and Samuelson 1987. January 1994. complete information renders no guarantee for immediate resolution of bargaining. No. is allowed to search while bargaining.in bargainingmodels with a search option. revisions received December 1992.. the buyer. bargainerswith "better" reservation prices tend to get better outcomes. Shaked (1987). The first result can be seen. a smaller search cost leads to a higher reservationprice for the seller and a lower reservation price for the buyer. and bargaining outcome depends crucially on the bargainers' intrinsic characteristics that determine their reservation prices. November-December 1994 1100 0030-364X194142061100 $01. 1990. (There are exceptions for different reasons. Since delay is costly for both players.g. see Rubinstein 1982 and Chatterjee et al. and Muthoo (1991). We find that. for example. or his search cost (e. All of these complete information models predict immediate resolution of bargaining. This paper considers a bilateralbargainingproblem with complete information in which one of the bargainers. Shaked and Sutton (1989). and the effect of changing the buyer's search cost on each player's bargaining outcome is unpredictable. delay can occur when the players have incomplete information. and. 1988). Chikte and Deshmukh found that search costs are closely related to players' reservation prices. Operations Research Vol. for instance. it is then to both players' advantage to resolve bargaining immediately. This paper considers a bilateral bargaining problem with complete information in which one of the bargainers. New Territories. The major driving force of these two results is the assumption that the buyer can recall past outside offers. 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions . 42.25 ? 1994 Operations Research Society of America This content downloaded from 158.BARGAININGAND NEGOTIATION. fixed time interval T within which players cannot switch in Shaked and Sutton). Chikte and Deshmukh). In addition.170. and in the bargainingand search models of Wolinsky (1987). the buyer. but search never takes place. we assume that the buyer is allowed to recall past outside offers. TJ'wostandardresults of previous bargainingmode s state that delay is generally not expected to occur under complete information. and the effect of changing the buyer's search cost on each player's bargaining outcome is unpredictable. In particular. his freedom to switch bargainingpartners (e. The Subject classifications: Games/group decisions.6. bargaining: bargaining and search with recall. the ability to search enables a bargainer to improve his bargainingoutcome. in the bargainingmodel of Rubinstein (1982). Under this argument. The "intrinsic" characteristic of a player mentioned in the second result can be a player's time preference (e. Chikte and Deshmukh (1987). 6. We find that. quite contrary to the standard results of previous complete information bargaining models. and bargaining outcome depends crucially on the bargainers' intrinsic characteristics that determine their reservation prices. Fudenberg and Tirole 1983. they concluded that a decrease in a player's search cost can increase his payoff without increasing the other player's payoff.In particular. The intuition for the no-delay result is straightforward. Hong Kong (Received September 1991. there is no need for players to spend time in exploring each other's bargainingstrength. If everything is known to every player.. is allowed to search while bargaining. that is. More importantly. accepted May 1994) Two standard results of previous bargaining models state that delay is generally not expected to occur under complete information. The main feature that distinguishes this model from other bargaining and search models is that the buyer is allowed to hold onto the outside offers he receives through search in the entire bargainingprocess.g. Sobel and Takahashi 1983. in general.in the bargaining with outside option models of Shaked and Sutton (1984). in general.g.

Otherwise. Section 2 derives the equilibrium. The employer makes an offer initially. he pays a cost c (c > 0) and then draws an outside offer x1 from the unit interval. otherwise. The employee-employer relationship is another example.44 on Thu. Hence. After observing x2. The buyer can then accept eitherp2 orx1 to end the game. The second period starts with the seller making an offerp2. the buyer will sometimes be referred to as "he" and the seller as "she" in the later discussions. Examples of this type of bargainingare abundantin real life. The bargaining and search process in the second period is basically a replica of that in the first period. orx2. Pi (which is still open) or neither. 1].The second result is in contrast to the result of Chikte and Deshmukh mentioned earlier. the realized values of outside offers. Section 3 provides detailed discussions for the major results of this paper along with an example. If the employee is satisfied with the offer. the buyer accepts one of the available offers. What should be most noted is that the buyer is allowed to recall x1. they often allow buyers to retain their offers for at least a given amount of time. in the car market.6. 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions . The organization of this paper is as follows: Section 1 describes the bargaining and search model. If he decides to accept an offer (x1 or P1). The buyer can either accept or reject pl. the game is over.x) and the seller's is zero. The basic intuition for the first result of this paper is that when the buyer's search cost is small. in the second period. and the game ends. P2. it may be too costly for the seller to deter search. are governed by the same probabilitydistributionfunction F(x) with support on [0. the game moves to its second period. This content downloaded from 158.and finally. the values of 8 and c. he will not search. respectively. Acceptance of Pi by the buyer ends the game and the good is then exchanged at the agreedupon price. he draws an outside offer x2 from the unit interval at cost c. we assume everything is known to both players-the structureof the game. instead of making a "low" offer to deter search. the seller's payoff is 5'-'p and the buyer's is 51-1(1 . the buyer can choose either "to search" or "to ask the seller for a second offer. If the buyer chooses to search. 1. verifiable alternative offers must be generated to improve his salary. or he can search. however. THE MODEL Consider a bilateral bargainingproblem in which one seller and one buyer are bargainingover the price of an indivisible good. the seller chooses to charge the buyer a "high" price knowing that the buyer will search and hoping that this "high" offer will be accepted later if the buyer's search turns out to be unfruitful. For convenience.LEE / 1101 major driving force of these results is the assumption that the buyer can recall past outside offers. If he chooses to search. For instance. the preferences of the players. would move the game to its second period.p1. Car dealers generally do not make take-it-or-leave-it offers. The density function of F(x) isf(x). Outside offers. On the other hand. Instead. Sometimes the Figure 1. but not p1. Finally. xl and x2. x1. The game tree of this model is depicted in Figure 1. The detail of this result will be provided in the sequel. If Pi is rejected. The seller initiates the game by making an offer. The game tree of the bargainingand search game.170.p). The seller's and the buyer's valuations of the good are 0 and 1." The latter option. to the buyer. If the seller and the buyer agree to exchange the good at price p in the ith period. if the buyer accepts an outside offerx in the ith period. a buyer will normally search around while bargainingwith a particular dealer. players' payoffs in the second period are discounted by the common discount factor 8 (8 S 1). the buyer can either accept xl. Once x1 is observed. his payoff is 51-1(1 . and the probability distribution function F(x) and its support. Furthermore.

(1 . THE ANALYSIS 2.so c cannot be "too large.F(p2)] over [0.F(fp)]. the set of probability distribution functions such thatp[l . F(x) = xm (m > 0). Letp be the unique maximizer of p2[1 . and only if. If the buyer did not search in the first period. if P2 >p if P2 <P* (3) subject to P2 To simplify the analysis. p* must satisfy the condition: 1 . P2. The reverse case can be proven similarly..e. and p[1 . denoted as S(p2). Let pi and xi be as defined previously and s = min [x1. Then.s < F(s) for all s >p*. To interpretLemma 1. The above analysis of each player's behavior in the second period is based on the presumption that the buyer has searched and obtained an outside offerx1 in the first period.&D(s)= fP* F(x2) dX2 . Lets E [0. the family of power functions. First. additionally. 1]. the seller's optimal strategy is slightly more complicated. p *.p* = ('(P*). A2: If the buyer is to accept a price among several prices of the same magnitude. (1 . Lemma 2 says that the buyer will not search in the second period unless min[xl. the seller's problem is to choose a price. P2] > P* Given the buyer's strategy.p*}(4) -c + f (1 -X2)f(X2) dX2 + I(1 Js . 2.s) .F(p2)] . The Second Period Behavior The solution concept used in this model is that of Subgame Perfect Equilibrium. s < p*. P2j.44 on Thu.170. Second. the solution to (3) depends on the values of x1. the more expensive it becomes to recall that offer. Define p" = inf{p2 Jp2[1 . Clearly. 1]. 1 . there must exist a unique p* for each c.F(p)] . I Max S(p2) = p2[ <x-l P2 .S)f(X2) dJC2 - ?(S)(l We assume that ?F(s)is nonnegative throughout. If p * < p [1 . satisfies this assumption. Then. Proof. Then. 1]. sometimes the alternatives are simply too good to be given up and the employee ends up taking the new job. the seller will offerp2 = min[x1. Lemma 1. and.F(p)] is strictly quasiconcave will be focused upon.F(p)] is strictly quasiconcave.6. the finalperson can always make his or her offer more attractive than any of the previous. in the second period. s = min[xl. One way to interpretAl is to consider players of the game as being "slightly" risk averse. by making his or her offer slightly smaller.((s) is positive if. This is stated formally as an assumption. p ] and the buyer will accept. (2) Since (2) is equivalent to c = fPO*F(x2) dx2. establishes that p * is the seller's largest possible search-deterringoffer in the second period. Then. A3: Here p[1 . the seller's problem in the second This content downloaded from 158.0f F(x2) dx2.s) . 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions .1.fl F(x2) dx2. This assumption guarantees thatp[1 . We now introduce the following two tie-breaking assumptions. he accepts the one that he received most recently. A2 can be justified in at least two ways. If p * > p[1 F(p-)]. Al: If a player is indifferentbetween taking an action A to get a sure payoff a and taking an action B to get a probabilistic payoff with an expectation of a.s) 4D(s) = c .F(p)] is single-peaked and contains no flat portion in the interior of [0. These assumptions will enable us to characterize a unique equilibriumfor each given value of c in the next section. the older an offer becomes. The optimal behavior described in the table can be checked by referringto Figure 2. andp* is increasing in c.F(p2)] . the buyer's expected payoff from a search given that he has searched in the first period is S our later analysis. Since c = fP* F(x2) dx2. Among commonly used distributionfunctions. which will be useful for The seller's offers and the buyer's accompanying responses in this case are summarizedin Table I." Let p* be the price which makes the buyer indifferent between searching and not searching in the second period.The key to the solution of this game is by backward induction starting from the second period. P2]). he takes action A. Then. we can imagine that there is a very small cost for the buyer to recall past offers.1102 / LEE alternatives are sufficient for the employee to convince his employer of a promotion. consider the s as the buyer's best available offer in the second period before search (i. The following lemma. Integration by parts yields that (1 . to maximize her second-period expected payoff. andl1 -s > (D(s)for alls <p*.

The Buyer's Behavior After First-Period Search After receiving an outside offer x1 from the first period search. the following discussions are separated into two cases: i) whenp* p-[1 .p*] x1 (p*. in which case. Recall in the previous discussion of the second-period behavior that.min [x1. then his first move. and then. possibly three. however. the buyer must decide whether to accept. after receiving the seller's offer. it must be the case that This content downloaded from 158. Since the seller will never offer any P2 less than min[x1. orxl) at the end of the first period or to go to the second period and ask the seller for a second offer. (5) Figure 2. the seller's first move. P2]) or 5I?(min[xl. If x1 S p *.1.F(p)]). or to ask the seller for a second offer. the buyer certainly will not go to the second period because he can simply accept x1 at the end of the first period. depending on whether or not he will search in the second period.p1]. when c is sufficiently large (i. the buyer can take one of the following two actions. 2.LEE / 1103 Table I The Seller's Offer and the Buyer's Response in the Second Period Given That the Buyer has Searched in the First Period andp* < p[1 . The seller will offer eitherp * orfp in the second period depending on which of p* and p[1 .p * 3 p[1 . he will then have to move againonce an outside offer is received. his decision regardingwhich action to take at the end of the firstperiod depends not only on the values of x1 and Pi. First. he can ask the seller for a new offer P2. Hence. Since the seller's second period offer depends on the values of p* and p-[1 F(p)]. but also on the projected value of P2.. Following the procedure of backward induction.e.min[x1.F(p)]. the most the buyer can obtain by going to the second period is 8(1 . the seller has to make an offer.p"] p* (p". in equilibrium. his payoff will be either 8(1 . "moves" in the first period of the game.min[x1. If the buyer chooses to search previously. In other words. [O. the buyer must make a decision regardingwhether to accept a price (p. the buyer's payoff for going to the second period is exactly 8(1 . p *]). 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions . because the seller will never offer any P2 greater thanp..44 on Thu.p > p*). our analysis of the first-period behavior starts from the buyer's second move. The buyer will accept immediately all prices less than or equal top* and search otherwise. and ii) when p* < p[l . he can accept the lower price of x1 andp1 to get 1 .p* < p[1 . Note that the value of p0 is crucial in determining the buyer's optimal strategy in the first period.F(p)] is larger. the first pertains to the seller. and the second and the third pertain to the buyer. except there is no constraintp2 < x1.min[xl. In fact.6.F(p)] Range ofx. the buyer's expected payoff for going to the second period is at least 8'F(p) (which is greater than 8(1 because. The third move may or may not be necessary depending on the buyer's choice made in the first move. 2.2. the most the buyer can get by going to the second period is 8(1 . let us now consider the players' behavior in the first period. p) xi [pI 1] Seller's Offer(P2) Buyer's Response p Accept Accept Search Search period is similar to the one given in (3).min[x1.F(fp)]).2. Let p0 be the price such that the buyer is indifferent between accepting p0 in the first period and accepting p* in the second period.F(p-)]Before proceeding. p*]. p*]). Second. Illustration of the players' behavior described in Table I. The First-Period Behavior There are at least two. p*]) regardless of the value of c. In his second move. First.170. p0 satisfies the equation: 1 -po = 8(1 -p*). When c is small (i. Hence. to search. if the second period is reached. a new notation will be introduced. Second. P2]).e. Having completed the analysis of the second period behavior.

allowing 8 to take other values will not lead to qualitatively different results. Whenp* <fp[1 -F(p)] [0. p* is defined as the seller's highest possible searchdeterring price in the second period. P2]). p* = p"). in the second search in the search in the period second period second period otherwise otherwise otherwise This content downloaded from 158. Since p0 can be smaller (for large 8) or larger (for small 8) than p" depending on the value of 8. however.2. 5'F(x) can be smaller than 1 . we know that p" is always greater than p* for c strictly greater than 0 (for c = 0. and otherwisewill search.x even if x > p" for 8 sufficiently small.min[x1. p1] Acceptp1 at the Acceptp1 at the Acceptp1 at the at the end of the at the end of the strategyat the end of the first end of the first end of the first end of the first period first period period if P1 < period if 1 period if 1 first period p0.min[x1. and ii.F(p)]. acceptp* Pi > 8&D(x1). these to the buyer's payoff. then. to keep things simple. However. It is easy to verify the information given in these two tables. Pl] P2]). acceptp * in the second periodotherwise (p". in turn. Since the actual value of p0 depends not only on p *. 1 -x < 8'(x) for allx >p".p*] x Accept min[pl. x1] at the end of the first period. That is. p* <p 0 <p".44 on Thu. 1] p* The resultingsecond period seller's offer Buyer's optimalstrategyat the end of the first period Range ofx1 p Accept min[p1. Two remarks must be made. it does not affect the major results of this model. the computation of the equilibriumof this game can become quite complicatedwithout knowing the actualvalue of 8. P2] > p*. Hence. 1 .P ] (po. less than or equal topo at the end of the first period.p*). Assumption A4 enables us to focus on a particular class of games whose equilibria can be derived in a similarmanner.x < ?F(x) for allx > p*. Table II The Buyer's Optimal Strategy at the End of the First Period Whenp* > p[1 . 2. part i of A4 ensures that 8 is large enough. The Buyer's Behavior Before First-Period Search Earlier in the analysis of the second-period behavior.1104 / LEE x1 > p*. p?] (P*. Knowing this. period if 1 . Part ii of A4 ensures that such cases are ruled out.p 1 p*. x1] at the end of the first period (P. the buyer will acceptpi immediately if.F(p)] Range ofx1 [O. If min[x1. For part i of A4. means that the most the buyer can obtain by going to the second period is actually 8(1 . P2] S p*. The buyer's optimal strategies at the end of the first period are described in Table II for the cases ofp * ? p[l . xl] at the end of the first period (P*.p1 orx1.If min[xl. The following lemma shows thatp* also plays the same role in the first period. P] (p. part ii of A4 makes sure that 8 is not "too small." By Lemma 1.2. P"] Acceptp1 at the end of the first period ifp1 < p0. 5F(P2)] and otherwise will go to the second period. if he accepts min [P1. the buyer will accept any offer. Hence. Pl] at the end of the first max[8(1 . by Lemma 1. that althoughA4 affects the ways that the equilibriaof the game are computed. and this. 1 . and only if.170.F(p)] andp* < p[1 .min[x1. In other words.6. search will take place in the second period and the buyer's expected payoff for Comparing going to the second period will be 5&F(P2). 1 . Pl] Accept min[xl. P i > &D(P). the following assumption is made. A4: Assume that 8 is close enough to one such that the following is true: i. It is worth mentioning. there will be no search in the second period and the buyer's payoff for going to the second period will be 8(1 . but also on 8 (p0 is close top* when 8 is close to 1 and is close to 1 when a is close to 0). Similarly. p*] 1] The resulting xp p* x1 P second period seller's offer Buyer's optimal Accept min[xl. Pl].x < ?F(x) for allx > p" because p" > p*. 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions .min[xl. the buyer will accept min[xl.

In this case. ifp * is sufficientlylarge (i.po < FD(p0).8(1 . the buyer will accept all seller offers less than or equal top * in the first period. When p * < p [ 1 . by Lemma 1. Lemma 2 also p * will be suggests that. As c -c + 0 max[1 -x1. is to accept the outside offerx1 if x1 < po. 1(p') > 1 . Hence. This content downloaded from 158.p *). Consider first the case when the seller offers Pi < p *. and once reached.F(p)]. In the first period.F(F)].p*).6. 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions . One may then suspect that. the buyer will either accept Pi immediately or accept min[p1. By Lemma 1. the buyer will search. x1] after search. The equilibriumdescribed in Proposition 1 requires the buyer's search cost to be sufficiently high. the seller's expected payoff for offeringp1 > p0 is 8p*[l . it is clearly not optimal for the seller to offerp1 E (p*. and ii) whenp* < p-[1 .p' > p* because b8(3P) < 1 . Proposition 1. 2. c is sufficientlylarge). consider the case when the seller offersp1 > p*. and will search if the seller's first period offer is greater than p *. Proof.LEE / 1105 Lemma 2.po). the seller can guarantee herself a payoff of p * by offeringp1 = p* in the first period. This is indeed the case. By Lemma 1.F(p?)]. we need only to consider the buyer's payoff if he searches and his payoff if he goes directly to the second period. which is clearly less thanp* .Then.F(p)]. the buyer will search.. Now. whereas his expected payoff from search is at least -c + f 0 PI max[1 -xl.p'. and otherwise to accept the seller's second offer p * in the second period. In particular. Therefore. Sincep* > p[1 . by Lemma 3. sincep1 p *. Obviously.F(P) ]. Therefore. the buyer will search. Hence. p?0]. which is greaterthan 1 -P1 becausep1 >p*. the seller will then have incentive to end the game immediately. The Seller's Behavior in the First Period Lemma 2 greatly simplifies the analysis for the seller's equilibrium offer in the first period. since po > p*. according to Table II.e. by Lemma 2. consider the case ifp1 > p0. the seller will never offer any price less thanp . Proof.p* and. as discussed previously. this game has a unique subgame perfect equilibrium in which the seller offers p * in the first period and the buyer accepts immediately. Hence.F(Q)]. and the buyer's post-search behavior. wherep' = 1 - SFD(p). consider the case when the seller's first period offer is strictly greater thanp *. the buyer will acceptp immediately. 5'F(p)]f(xi) dx1 = -c + J (1 -xl)f(xl) dxl + J (1 -p')f(xi) dxl = 'D(p'). the buyer's payoff for F[1 Whenp* going directly to the second period is 8(1 . 5 . Since the buyer can always recallp1 after search. the seller will offerp2 = p* and the buyer will accept. whereas his expected payoff from search is at least 1 Clearly. the expected payoff from search will be at least 'F(p1). Since. the buyer will search and the post-search behavior (see the first part of Table II) is to accept the outside offerx1 if x1 S P1. the buyer will accept immediately any seller offer less than or equal to p *. the unique equilibriumis for the seller to offerp * in the first period and for the buyer to accept p * immediately.44 on Thu. as defined in (5).F(p)] by our assumption. the buyer's payoff for going directly to the second period is 8C(p).p*) (= 1 . we know that the second period will not be reached because. Then. and otherwise to acceptp1 at the end of the firstperiod.170.2. because all seller offersp1 p accepted immediately by the buyer.3. P?]Next.F(p?).F(p1)] for allp1. again by Lemma 3. In other words.let us consider first ifp1 E (p *. Hence. the second period will be reached with probability 1 . 1 . Whenp* ? p[1 . 8(1 -p*)]f(xl) dx1 = -c + + J 0 (1 -xl)f(xl) dx1 j (1 -p0)f(xl) dxl =-?(po) where po = 1 . the buyer will not acceptp1 immediately.F(p1) and the second period will never be reached. Now. We consider two cases: i) when p* p[1 . p* ? p1[1 . Clearly.F(p1)] becausep1 will be accepted at the end of the first period with probability 1 . The seller's expected payoff for makingsuch an offer isp1[1 . The following proposition gives the sufficient condition for the immediate resolution of bargaining. the buyer's payoff for going to the second period is at most b(1 .

Hence. First of all. based on the buyer's postsearch behavior described in Table II. Hence.8F(p") > p0 because 1 . it is obvious that she will not offer any price strictly less thanp* in the first period in equilibrium. Hence. any seller strategy which chooses a price in (p?.asD(p) ? 1 . 1 . the buyer will search and.Pi. (po. then there must exist a price. Since Pi E (p*. Consider the case if the seller offers p1 > 1 8(D(p). 1]. 1 8F(p")) as her first-period offer cannot be an equilibrium strategy. forp1 in these ranges. the seller may no longer have an incentive to end bargaining immediately. Furthermore. the seller's expected payoff will be P" Sp*f(X ) dx + p j 8x1[1 -F(xl)]f(xl) dxl + | P[l -F(p)]f(xj) dx1.F(p)] being strictly quasiconcave implies thatp[l . Hence. po] can be the seller's equilibrium first-period offer. Eventually. p]. the informationgiven in the second part of Table II will be useful for computing the seller's expected payoffs in these cases. Note that if x1 E (p". then. in [p". since the seller can get p * by offering p1 = p*. the value of p* decreases and the seller's payoff in this equilibrium also decreases.F(p")] because p 1 and p" are both less than p and p" > P1.170. p[l . p] such that Pi = 1 8D(x*(p1)). (8) Since 1 . that Pi = 1 8FD(p")is not ruled out as a possible equilibrium first-periodoffer. p?]. 1 . In the following discussion. Also.S?(p")) can also be ruled out as the seller's equilibriumfirstperiod offer. the seller is better off offering p * directly instead of offering a price in (p*. p?]. her expected payoff will be j P P pp*f(X ) dx1 + x 8x[1 -F(xl)]f(xl) dx + (1 - FD(pf))f(xj) dxl. the buyer would search and accept min[xl. after search in the first period. when c becomes sufficiently small (i.F(p 1)] S p"[l . p* < F[1 . First note that no price in (p *. p 1[1 . (6) If the seller offers a price p1 in the interval [1 8F(p`). we will argue that no price in the following intervals can be the seller's equilibrium first period offer: (p*. We can interpret x*(p1) as follows: x*(p1) is the outside offer which makes the buyer.&F(p"). the seller's expected payoff can be shown to be equal to: p". dx + p-[1 .1106 / LEE becomes smaller.?(p) p =c + jxf(x) > 8p-[l . if the seller offersp1 = 1 .e. We now turn our attention to this case. Note. Pi < P". again based on Table II.6.F(F)]). Then. To characterize the seller's optimal offer in the first period whenp* < p[1 .8F(p). the maximum of (6) is achieved atp1 = 1 . p0]. call it x*(p1). Any price in the open interval (p?.F(p)] is increasing inp forp < p. there is one more price range to be ruled out.&FD(p). If the seller were to make such an offer. offering P1 strictly greater than 1 . and (1 . the buyer's payoff for acceptingpl at the end of the first period is 1 . F]. Pi] after search. Hence.8F(p)]. 1 3&F(p")). since p * = p"[1 . Two possible candidates for the seller's equilibrium first-periodoffer now exist-one is p* and the other is a price in the closed interval [1 . let us first identify certain prices which cannot be the seller's equilibrium first period offer. Suppose that the seller offers a price in the half-open interval (p?. Notice that 1 .as'(p) because '(FQ) is a decreasing function and p" < p. 1 S(D (p)]- S 8*f(x ) dx1 + f plf(x1) dxl.F(p1)]. however.F(p)] the value of (8) is greater than that of (7). it is never optimal for the buyer to accept x1 at the end of the first period (see Table II). while his expected payoff for This content downloaded from 158. Also.F(p")]. 1 . if x1 E (p".F(p)]. Finally.po = 8(1 . indifferent between accepting Pi immediately and going to the second period to search. (7) However. Then. However..8F(p") < 1 . the buyer's best response is always "to search" according to Lemma 2. 1 Since (6) is clearly increasing in pl. 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions .F(p)].44 on Thu.S8F(p")]. 1 . the seller's equilibriumfirst period offer must be greater than or equal top*. by Lemma 2 and the second part of Table II. The seller's expected payoff for making such an offer is therefore pl[l . Hence.p*) = S8D(p*) > S(D(p").S&D(p").(D(p) in the first period cannot be optimal for the seller.

there is no reason for the seller to make an offer that will be rejected in the first place and will never be accepted in the future. the seller has two options. The seller's and the buyer's payoffs in this equilibrium are p* and 1 .81?(fP))f(x1)dxl.F(F)]. Regardless of the form of F(.F(p)]. the more attractiveis the first option to the seller. the seller's expected payoff for offering such ap1 in the first period will be P. the seller will offer P2 = x1 and the buyer will search.p*. (9) uniformly distributed on [0. examples can be found so that the first type of equilibrium cannot arise. it is not clear whether both types of equilibriaare always possible. However. Hence. pl]. the second type of equilibriumis always possible. consider again expression (9) and letpi = 1 . which can be shown by simple computation to be greater than p[1 . Hence.8(p)). This efficiency loss is due to the search cost paid by the buyer and the delay in reaching agreement. since agreement cannot be reached immediately by both players. see Table II. See the previous discussion. In fact. otherwise. ii.44 on Thu. p * depends on c. fp1 (1 . consider the last term of T(1 . 1 xfl[1 . he will go to the second period and search if x1 < x*(pl). Otherwise. (This is because. in which the seller makes an acceptable offerp* and the buyer accepts immediately in the beginning of the first period. Again. respectively.LEE / 1107 going to the second period and searching is &1(x1). the seller's incentive to deter + I 1 6(X1j)f(xj) dx + x*(ff) (1 -)f(xj) dx1. Consequently. T(P) _ T(1 .1.6. efficiency loss is inevitable. however. DISCUSSION 3. As c becomes smaller. Proposition 2. then the unique equilibriumis for the seller to offer p1 = p and the buyer to search in the first period. the first type of equilibrium arises. one of the following will be the unique equilibriumof the game: i.170. she can charge the buyer a reasonable price p * to deter search.) Therefore. at the end of the first period. for the seller's second option to be a viable strategy.F(p)]2.F(xl)]f(xl) dxl + x*(pO) p1f(x1)dx1 P(p1). it is necessary to allow the buyer to hold onto the seller's offer for a given amountof time. it can be shown that. (p)] be the maximizer (assumed unique) and T(fl) be the maximumvalue of (9). The seller's (ex ante) expected payoff in this equilibriumis T(p) and the buyer's is -c+ (1-xj)f(xi) dxl + J (1-p*)f(xj) dxl 3. the two conditions required by the first type of equilibrium. there must exist some c (which are small enough) such that p * < p [ 1 . in which the seller offers a relatively high pricefl in the first period and the buyer searches. Intuitively. 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions . S p*f(xl) x*(pI) dx + p.8'F(p).8(p)). Second.. Notice thatp[1 . Proposition 2 delineates two types of equilibriathat may arise under the condition p* < p[1 .). For instance. Since the search-deterringpricep * is increasing in c. if outside offers are This content downloaded from 158. Yet. there must exist some c such that p* < T 1Let P E [1 .F(p-)] and p* > T(fl). given a sufficiently small c. If p* > P(13). knowing that the buyer will search and hoping that this high offer will eventually be accepted due to an unfruitful search. then the seller will offer eitherp* or p5in the first period dependingon the value of p* and T(fl). The bargaining outcome in the first type of equilibrium is efficient because bargainingends immediately without delay. she can make a high offer. the buyer will acceptp 1 if x 1 > x *(p 1).p * approaches zero as well. (10) Proof. the unique equilibrium is for the seller to offer P1 = p * in the first period and the buyer to accept immediately. if the buyer goes to the second period with an outside offer x1 E [p". what happens is the following. Note that.F(p)]2 is a positive constant. Whenp* < p-[1 . as c approaches zero. The Main Results Propositions 1 and 2 suggest that this game has two types of equilibria.F(fp)]2. p* < p[l . Since p is the unique optimal offer in this equilibrium. cannot be satisfied simultaneously. In fact. the second type of equilibriumarises. To see this..SF(p"). 1]. When c is large. If p* < T((p). Now. the larger c is. When c is sufficiently small. First. In the second type of equilibrium. In the first period.

E. It is only when the buyer's first period outside offer is neither good nor bad (i. x1 > x*(jp)). In this case.. suppose the buyer's first-periodoutside offer is slightly smaller than x*(f). whenp* ? p[l .8(5/8 . Second. This happens when x1 E (p". An Example The following example is constructed by assuming outside offers to be uniformly distributedfrom 0 to 1. P = 1 . p"].44 on Thu. one of these two types of equilibriawill arise.. in c.1108 / LEE search decreases. Two remarks should be made on how the assumption of allowing recall affects the results of this model. Computation of the equilibriumexpected payoffs for both players in each of the three models indicates that the buyer's equilibriumexpected payoff is the highestin the "full recall"model andis the lowest in the "no recall" model. The buyer's This content downloaded from 158. the buyer may feel that. The seller's and the buyer's (ex-ante) expected payoffs in this equilibrium are the same as those defined in (9) and (10) withp 1 = 5= 1 . where the same second type of equilibrium is supposed to be played. it will not be presented here.e. and the second variationdoes not allow the buyer to recall any offer. shows that this intuition is correct only when c ? 1/32.(2c) . Even for c < 1/32. two variations of this model were considered-the first variation allows the buyer to recall all past offers (includingthe seller's offers). In the earlierversion of this paper. Then. Depending on the value of c. there is a sudden jump in both players' expected payoff functions for moving from c < 1/32 to c > 1/32 due to differenttypes of equilibria in effect.F(p). and vice versa for the seller. When F(-) is uniform. it should be easy to verify that p* = (2c) 1"2 andp = 1/2. To see how this can happen. Furthermore. 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions . recall that the seller's first period offer in the second type of equilibriumisp 1 = P. Figure 3.(2c)12). Since x*(p) is strictly greater than fl. If this occurs. In this case. when c becomes sufficiently small.F(p)]). the game proceeds to the end of the second period. The seller's and the buyer's equilibriumexpected payoffs when 6 = 1 are plotted in Figure 3. the second option becomes the better one. the buyer will go to the second period and the seller will offer P2 = X*(f) . In this equilibrium.. the more freedom the buyer has to recall past offers.F(p)]). the buyer will become pessimistic about his bargaining situation in the second period and will accept reluctantly the seller's offerp1 = fl at the end of the first period. Now. the seller's payoff is (2c)1/2 and the buyer's is 1 . In this case.e. This is the case when the buyer goes to the second period with an outside offer x1 E (p?.8(5/8 . where the first type of equilibrium is supposed to be played. it is interesting to note that the seller's second period offer may be higher than her first period offer. x1 < p?) in the firstperiod. there must exist some E such that x*(Q) . x* (p)). the seller offers p2 = p* (< x1) in the second period and the buyer accepts. it may be worthwhile to search again in the second period.e. First. the game has a unique equilibriumin which the seller offersp1 = (2c)1/2 in the first period and the buyer accepts immediately. the buyerwill be satisfiedwith what he has and will accept the outside offer. Second. The probability that the second period will be reached is F(x*(f)) . When the second type of equilibrium arises. 3. When the buyer goes to the second period due to the second reason mentioned above.. The detail is availableupon request. First.e. Intuitively.c) in the first period and the buyer searches. the buyer may believe that he has received a good outside offer (although not good enough to be accepted immediately)which can be used to convince the seller to make a better offer. By part ii of A4. p0 < xi < x*(p)) that the second period will be reached..E. The first situationis when the buyer receives a satisfyingoutside offer (i.2. x*(j) = 1/2. both players' expected payoffs are convex. Type 2 Equilibrium. When c ? 1/32 (i. the second period may or may not be reached depending on the outcome of the buyer's first period search. the better is his equilibrium expected payoff and the worse is the seller's. Since the derivation for the equilibria of these two variations is quite tedious and provides no additional insight into the problem. whenp* < p[l . Eventually. there are two situations underwhich the game ends at the end of the first period. but not monotonic.170. Type 1 Equilibrium. When c < 1/32 (i. and po = 1 .e. however. The buyer goes to the second period for one of two reasons. we may expect the buyer's equilibriumexpected payoff to be decreasing and the seller's to be increasing in c. The second case arises when the buyer receives a discouragingoutside offer (i. In other words.8 (1 .6F(x* (P)) < x *(P) (because x * (P) > p ) . considering the outside offer received in the first period. the game has a unique equilibriumin which the seller offersp1 = 1 .E > 5. say x1 = x*(ff) .6. it is easy to check that the game will end immediately if the buyer cannot recall any of the past offers. It is interesting to see in Figure 3 how each player's equilibriumexpected payoff depends on c.c).

Departmentof ManagementSciences and InformationSystems. ACKNOWLEDGMENT I thank Kalyan Chatteree. D. Econometrica 52. J. 36. Studies 54. Econ. FUDENBERG.. Opns. 104.Discussion Paper87/159(Theoretical Economics). SAMUELSON. 753-770. Theory 39. 35. U. CHATrERJEE 1987. Larry Kranich.. This content downloaded from 158. CHIKTE. 21 Nov 2013 15:45:11 PM All use subject to JSTOR Terms and Conditions . Opting Out: Bazaars Versus 'High SHAKED. ANDJ. if the buyer's search cost is any indicationat all of his bargainingpower. ANDJ. 1987.Search. The Role of expected payoffjumps to a higherlevel and the seller's drops to a lower level. 1982. Sequential Bargain- ing Under Asymmetric Information. Figure 3. 221-247. CHATTERJEE.. ANDL. TIROLE. PERRY. of Bargaining. D. Model. Econometnca 50(1). SHAKEDAND J. 1990. K. 175-192. not when c is infinitesimallysmall. Matching. WorkingPaper No. Tech' Markets. K.Res. it is when c is in some intermediate range that his bargainingpower is the strongest. A Note on the Strategic Role of Outside Options in Bilateral Bargaining..A.170. 1986.A NoncooperativeTheoryof Coalitional Bargaining. U. J. In fact. Under Two-sided Incomplete Information:The UnrestrictedOffersCase. the effect of changingthe buyer's search cost on each player's equilibriumexpected payoff is practicallyunpredictable..6. G. and two anonymous referees for their helpful comments. Studies. 198-205. A. 1987. DESHMUKH. SHAKED. AND L. 1983. Res. Econ. A. 605-618. MuTHoo.Rev. SOBEL. ExternalSearchin BilateralBargaining.K. 1351-1364. A Multistage Model J. Studies.Rev. A.Increasing (or decreasing)the buyer's search cost could make both players better off or worse off. gaining With Incomplete Information. S. Theory 42. SAMUELSON.. 90-10. RAY AND K. WOLINSKY. Perfect Equilibrium in a Bargaining RUBINSTEIN. S. London School of Economics. 1983. 1988. University Park.K. or it could make one player worse off and the other better off-all depending on where the change occurs. due to the convexity and the discontinuity in each player's expected payoff function. the buyer's payoff is the highest and the seller's the lowest at c = 1/32. Econ. Opns. AND M. Suntory Toyota International Centre for Economics and Related Disciplines.. Pennsylvania State University. BINMORE.K.Unpublished Paper. 120-154. SUYrON. Hence. Econ. In short. 411-426. ANDS. 31 1-333. Departmentof Economics. Research support from the Center for Research in Conflict and Negotiation at the Pennsylvania State University is gratefully acknowledged. B. D. Bargaining CHATrERJEE. Rev.1984. TAKAHASHI. London School of Economics.44 on Thu. GROSSMAN. A. Econ. J. Motty Perry. A. Involuntary Unem- ployment as a Perfect Equilibrium in a Bargaining Model. With Two-Sided IncompleteInformation: An Infinite Horizon Model With AlternatingOffers.. Players' equilibrium expected payoffs in the uniform example. SUTrON. Penn. DUTTA. SENGUPTA.Quart. Bargaining K. An Outside Option Experiment. Econ. 1989..LEE / 1109 REFERENCES 1989. 1987. ANDI. and Bargaining. Sequential BarD.