You are on page 1of 18

Bargaining under Incomplete Information Author(s): Kalyan Chatterjee and William Samuelson Source: Operations Research, Vol. 31, No.

5 (Sep. - Oct., 1983), pp. 835-851 Published by: INFORMS Stable URL: http://www.jstor.org/stable/170889 . Accessed: 21/11/2013 15:46
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp

.
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

.

INFORMS is collaborating with JSTOR to digitize, preserve and extend access to Operations Research.

http://www.jstor.org

This content downloaded from 158.170.6.44 on Thu, 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions

Our principal aim is to investigate equilibrium bargaining behavior under uncertainty and to study how the parties fare.Applicationsof the model rangefrom the settlement of a claim out of court. of the Nash solutionconcept. in haggling over the price of a used car. The Nash equilibrium game impliesan offerstrategy of each partythat is monotonicin its own reservation price and depends on its assessment of the opponent's reservationprice. Issues of relative bargainingadvantage and efficiency are examined for a we discuss the appropriateness numberof special cases. under a simple class of bargainingprocedures. individually and collectively. Underthe bargaining ruleproposed. September-October 1983 ? 1983Operations ResearchSocietyof America This content downloaded from 158. The common feature shared by these examples is that each bargainer. has only probabilisticinformation concerning the potential value of the other.acceptedApril 1983) This paper presents and analyzes a bargaining model of bilateral monopoly underuncertainty. neither buyer nor seller knows the other's walk-awayprice.to union-managementnegotiations.the buyerand the seller each submitsealed offers that determinewhetherthe good in questionis sold solutionof this bargaining and the transferprice. 835 Operations Research 0030-364X/83/3105-0835 $01. For instance. given incomplete information.A main result is that. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . No.Massachusetts (ReceivedJuly 1981. while certain of the potential value it places on the transaction. THIS PAPER presents a simple model of two-person bargaining underincomplete information.Bargaining under Incomplete Information KALYAN CHATTERJEE PennsylvaniaState University.revisedApril 1982. 31.Even when the buyer values the good more highly than the seller.UniversityPark. Additionally. to the purchase and sale of a used automobile.170.44 on Thu. Finally.25 Vol. a successful sale may be impossible. not all mutually beneficial agreements can be attained via bargaining.6.Boston. Pennsylvania WILLIAM SAMUELSON Boston University. 5.we present a number of results characterizingthe players' optimal bargainingstrategies and give explicit solutions for a numberof examples. 232 bargaining. These examples provide useful comparativestatics resultsindicatingthe effect on bargainingbehaviorof changes in the negotiation Subject classification: 231 bargaining.

6. it is customaryto stipulate that the set of possible actions of the parties and the player payoffs from any combination of actions are common knowledge. in general. Young [1975] provides an excellent summary and critique of the most important literatureon the bargainingproblem.bargaining solutions are usually determined either by specifying a concession mechanism leading to a distinct outcome. Second. Cross [1969]. The application of these ideas to the bargaining problem is found in Harsanyi and Selten [1972]. Harsanyi [1956]. we frame the bargainingsituation as a noncooperativegame and focus on the resulting set of equilibriumoutcomes. as has been recently noted by Samuelson [1980] and Crawford [1982]. Since any price in this range can be supportedas an equilibriumoutcome. each party's bargainingstrategy will depend directly on the informationit possesses about his adversary's possible payoffs. the employment of optimal bargaining strategies may result in the breakdown of negotiations altogether-this despite the fact that a mutually beneficial agreement may exist ex post. Completevs. A bargaining model that embraces these features carries a numberof noteworthy implications. In two-person bargains (to which our discussion will be limited). Bargaining under uncertainty will.44 on Thu. or a set of axioms that a "reasonable" outcome should satisfy. IncompleteInformation. however. Like Harsanyi and Selten. The present paper examines these issues by modelingbargainingas a game of incomplete information following the pioneering approach of Harsanyi [1967-1968]. strikes. fail to be Pareto efficient. Then the bargainersnegotiate a final price in the known range of mutually acceptableprices (i. with the presumption of complete information.e. In other respects.Most game-theoretic literature on bargaininghas assumed that the participantspossess complete information about the negotiation situation. and Roth [1979]. Despite its many insights.our methods differ. First. as shown in later examples. the more optimistic a player's assessment of his opponent's stake in the negotiation.836 Chatterjee andSamuelson groundrules. For instance.seller and buyer.170. and 2) the occurrence of "unreasonable" bargaining outcomes-breakdowns in negotiations. the more aggressive it can afford to be when bargaining. knows the other's walk-awayprice. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . Important contributions are provided by Nash [1950]. the complete information approachfails to mirrorkey features of actual negotiations:1) the fact that each bargainer is uncertain about its adversary's payoff. and the degree of the players' risk aversion. each bargainer. we substitute a single stage bargaining This content downloaded from 158.First. between the seller's minimumand the buyer'smaximumacceptableprices). In the model of bilateral monopoly considered here. the informationavailable to the players. and work stoppages-when mutually beneficial agreements are possible. Schelling [1960].

Though abstractingfrom the dynamics of the negotiation process. Since a bargain is struck only when it is agreeableto both parties. A successful bargain is concluded if and only if the good is transferred at a mutually acceptable price. at the same time. the assumption facilitates the presentation of comparativestatics results for specific examples.44 on Thu. let Ub denote the buyer's reservation price (the greatest sum he is willing to pay for the good). the sale price P must satisfy us < P c Ub if such an interval exists. but is uncertain about his adversary's. a transaction is concludedat a price that depends on the offers. then no transaction takes place. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions .e.Ouraim is to investigateplayerbargaining strategies-that is.170. 1.e.assessing a subjectiveprobabilitydistributionover the range of possible values that his opponent might hold. By making a more aggressiveprice offer. our approachemploys continuous distributionsto summarize the probability beliefs of the bargainerswhereas Hansanyi and Selten focus on discretedistributions. the single stage bargaining procedureemphasizes the basic strategy trade-off faced by each player. Second.the bargainers submitprice offers. increases the risk of a disagreement(i.and Myerson and Satterthwaite [1981] have examined the performanceof arbitrationproceduresin the bargainingcontext. a player earns a greaterprofit in the event of an agreementbut. the mapping between the continuum of possible values that a player might hold and its price offers. Similarly.our emphasis is on individual bargainingstrategy and not on arbitrationperformance. Acting independently and without prior communication. and relative bargainingadvantage. Let us denote the seller's reservationprice-the smallest monetarysum he will accept in exchange for the good (independent of his level of income). Recently. a numberof authors (Rosenthal [1978]. The use of continuous distributionsallows us to characterizea class of equilibriain which these bargainingstrategies are well-behaved (i.6. THE BASIC MODEL Our analysis investigates bargainingbehavior in the well-known case of bilateral monopoly. differentiable). that his offer is unacceptableto the other). Incomplete information of the bargainersis modeled by the following assumption:Each party knows his own reservationprice. Myerson [1979]. While our model offers predictions about the frequency of negotiation breakdown.bargaining efficiency.if they are not. Specifically.UnderIncompleteInformation Bargaining 837 procedure for the multistage representation of Harsanyi and Selten. If these offers are compatible(in a sense to be defined later).Additionally. the buyer regards us as a random variable possessing a cumulative This content downloaded from 158. Suppose that a single seller of an indivisible good faces a single potential buyer.

k)s. In this instance. Fj(vi). each player earns a profit measured by the differencebetween the agreedprice and his reservationprice (P . for i = s. b. the rule is equivalentto grantingthe buyerthe right to make a first and final offer that the seller can accept or reject. Vb) = f (Vb - P)gb(s)ds if b ?> s = 0 if b < s.e. The seller's optimal strategy is to submit offers s = us for all us (i. and so forth.170.knows that they are known by the other side. Similarly. where 0 c k c 1. and which is strictly increasing and differentiable on [NbN Nb].44 on Thu. Fi(vj). the sale price is determined solely by the buyer's offer. In this framework.us for the seller and Vb. each side knows these distributions. knows that the latter knowledgeis known. P = kb + (1 . When k equals 1. we assume that each bargainermakes offers to maximize his expected profit. s].each earns a zero profit. The upper This content downloaded from 158. and the knowledgeof the opponent's assessment. we will characterizethe resulting Nash or Bayesian equilibriumsolutions. Finally. Framing the single stage bargain as a noncooperativegame. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . s and b respectively.setting k = 0 effectively grants the seller the first-offer right. when k = 1/2. and which is strictly increasingand differentiableon [vs. Additionally. the expected profit of the buyer is given by rb Wb(b. a bargain is enacted and the good is sold at price. In the event of an agreement.6. The notation b = B(vb) and s = S(vu) indicates that the players' price offers depend on their respective reservationprices. while the seller's offer serves only to determine whether there is an agreement or not. the rule determines a final sale price by splitting the difference between the player offers.The seller's knowledge of Ub is summarizedby F8(vb) which satisfies F8(Lb) = 0 and Fs(Ob) = 1. in the event of no agreement. and an agreementis reachedif and only if b > s. Then. where gb(s) is the density function of seller offers induced by the offer strategy So) and the underlyingdistributionof values Fb(vu). Both offers carry equal weight in determining the sale price. Seller and buyer submit sealed offers. there is no sale and no money trades hands. If b < s. If b > s. The functions B( ) and So ) will be referredto as the player offer strategies. These distribution functions are common knowledge in the sense of Aumann [1976]-that is.838 andSamuelson Chatterjee distributionfunction Fb(vu) satisfyingFb(vs) = 0 and Fb(08) = 1. Special cases of this rule are of some interest.bargaining behavior depends on a player's reservation price vi. his reservation price).P for the buyer). his assessment of the opponent's reservationprice. We will consider the following simple bargainingprocedure: BargainingRule.

44 on Thu. vs) ? ws(s. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . = f (P - vs)gs(b)db if s < =0 if s>b.Bargaining UnderIncompleteInformation 839 and lower supports of the offer distribution are s and s. A pair of best response offer strategies constitute a Nash (or Bayesian) equilibrium. PROPERTIES OF EQUILIBRIUM STRATEGIES This section presents a number of results characterizingthe equilibrium offer strategies of the bargaininggame.g. The proof of this result requires no special assumptions about the offer strategies (e. these inequalities.these offer strategies are not very interesting. neither player can increase his expected profit by unilaterally altering his chosen strategy. continuity or differentiability).wb(b. Vb') Vb') ! Wb(b.6. and Vbconstitute a no trade equilibrium.Vb').Vb). we find Wb(b. the seller proof is analogous. Vb) + - 1b(b. Vb) . Then by assumption. the expected profit of a seller with value vs who makes offer s and faces a potential buyer using offer strategy B( ) is rb v) wrs(s. the equilibrium bargaining strategies of the buyer and seller are increasing in the respective reservation prices. 9Vb) = Gb(b)(vb' - Vb) where Gb(b) is the cumulative distri- This content downloaded from 158.the higher the price he demands (offers). for all v. We present the proof for only the buyer offer function B( ). respectively. A fundamentalpropertyof equilibriumoffer strategiesfor which trades occur is that they are increasingin the individualreservationprices. vs). The results in this section describe equilibria in which an agreement occurs with a positive probability. a buyer holding Vbmakes offer b* that is a best response against So )if lrb(b*. Wb(b. Combining ? 0. Vb). Proof. Similarly.170. 2. for all s. 7Wb(b. Offer strategies satisfying S(V. Conditional on vs. Similarly. and wb(b. THEOREM1. Vb) - ?7b(b'. Vb') (2) The expression for the buyer's expected profit in (1) implies that Vb') -lrb(b. Obviously. The higher the value placed on the good by the seller (buyer). the seller's offer s* is a best response against B( ) if ws(s*.) > Vb and B(vb) < v. b(b'. for all b. Then player i employs a best response strategy if for each vi his offer is a best response against his opponent's strategy. Vb) ? Wb(b. ConsiderVband Vb' such that Vb=# Vb' and let b and b' be the buyer'soptimal offers for these respectivevalues.By definition. Under the sealed offer bargaining rule.

After noting that gb(b) = fb(y)/S'(y) and Vb= B`1(Sy)).This illustrates the basic principle that a player should never place an offer in an interval where the other player makes no offer.6.e.kGb(b) = 0. is identical to (3a). Theorems 2 and 3 that follow characterizeclass A equilibria. which. For Vb' > vb. Proof. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions .840 and Samuelson Chatterjee bution function of s. If b' were smaller than b.This would imply that b' and not b was optimal for Vb-a contradiction. Vb) = Gb(b')(vb' -Vb). b' > b when the strict inequality holds.k)s] gb(s)ds. arslas = (vs . His expected profit rb 71b(b. Vb) = f [vb - kb .the buyer'sprofit maximizationbehaviorensures that b' > b. we can rewritethe first order condition as [B-1(S(y)) - S(y)]fb(b) - kS'(y)Fb(y) = 0. where S1 is the inverse offer function. In turn.k)(1 is - F. a buyer holding Ub could lower his offer to b' and increase his profit in the event of a bargain without affecting the probabilityof a bargain. Since Gb() is a Gb(b)][Vb' distributionfunction.(1 .(x). Equivalently. Then by employing the dummy variable x = B '(s) and making the appropriatesubstitutions.44 on Thu. The first order condition for a maximumis Owb/ib = (Vb - b)gb(b) . Start with the buyer's equilibriumstrategy. In a class A equilibrium. 2. If Gb(b') = Gb(b). over intervals of reservation prices THEOREM for which the offer strategies are strictly increasing. we arrive at (3b). So ) and B( ) must satisfy the linked differential equations kFb(y)S'(y) + fb(y)S(y) = B1(S(y))fb(y) (3a) (3b) (1 . Substituting these expressions into (2) yields [Gb(b') Vb] = 0. Note that Gb(b) = Fb(S1(b)). then Gb(b') > Gb(b). Vb)7b(b. Gb(b) = Fb(y). i. the seller's first ordercondition is k)(1 . where y is a dummy variable defined so that b = S(y).Gs(s)) = 0.s)gs(s) + (1 - This content downloaded from 158. it follows that 7rb(b . Vs = S1(b). Similarly. after some rearrangement.(x))B'(x) - fs(x)B(x) = -S-1(B(x))f. Our principal objective is to characterize the class of equilibria for which player offer strategies are well-behaved.170. We shall consider the family A of equilibriafor which the following assumption is met: Each offer strategy is bounded above and below and is strictly increasingand differentiable except possibly at these offer bounds.

The equations are a precise expression of the fact that a player'soptimal price offer dependsnot only on vi and Fi(vj). the seller's expected profit is =kf rs(s.44 on Thu. It is straightforward to check that the seller's best response strategy is unchangedwith this modificationin the buyer'soptimal strategy.170. S(vs) establishes the upperbound for both the buyer and seller offers. Similarly.We denote the correspondinginverse functions similarly. For referencepurposes. the buyer's precise offer strategy is largelyirrelevantsince in equilibriumno bargain will ever be concluded. Since these functions are strictly increasing. In this case.Against the buyer's modified strategy. for Vb when he knows a successful bargain is certain. but also indirectly on Fj(vi) since the latter influences the opponent's strategy. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . When the buyer employs B). For lower and lower buyer values.Bargaining UnderIncompleteInformation 841 differentialequationsindicatingthat Equations 3a and 3b are "linked" the player strategies are interdependent. A buyer with Vb in this range faces only one restriction-that his offer be smaller than B(vb) in orderto preservethe This content downloaded from 158. the probabilityof a bargain first goes to zero at Vb = S(8s). a bargain is impossible for sufficiently low buyer reservation prices. a bargain first becomes a certainty when B(Vb) = S(&s)-when the buyer's offer just matches the greatest possible seller offer. the buyer makes the truthful offer B(vb) = Vb only at Vb =9S(L).) and B(vb) < S(vs).6. Vs) +k bgs(b)db f S(vs)gs(b)db rb + [(1-k)s - vs] gs(b)db. it is suboptimal for the buyer to match the lowest seller offer since by bidding instead in the interval (S(V8). S(v&) To illustrate the nature of the boundary solutions consider the case when B(Mb)> S(v. since he increases his profit in instances B(vb) = S(0s). B( ) describes the buyer'soptimal strategy only for the interval of reservationprices where the probabilityof a successful bargainis positive but smaller than unity. (At a reservation price greater than this. Vb). In this case. he can earn a positive profit. Thus. in the case that B(vb) < S(s). Differentiatingthis expression with respect to s yields precisely the first ordercondition of Theorem 2.) For Vb < S(v8).we denote the solutions to (3a) and (3b) over an unrestrictedrange of reservationprices by S( ) and B( ) respectively. Equivalently. We can now characterizethe equilibriumstrategiesat the offerbounds.Clearly.the maximumand minimumprice offers are and S(L) for the seller and B(vb) and B(vb) for the buyer. this occurs at value Vb = BA-(S(Vs)). the buyer improves upon B( ) by employing the constant offer strategy > B-(S(1)).

ii) The buyer'sexpected profit is 7rb(k)= (0/48)(1 + k)2(2 ./(2 - k)/2)0 k) + ((1 - k)/2)vt for ((2 - - k)/2) v < vs < 0 Vb < B(vb) < vb/(1 + k) + (k(l k)/2(1 + k))0 for 0 c ((1V C k)/2)v Vb C B(vb) = vb/(l + k) + (k(l - k)/2(1 + k))o for ((1 . iii) The sum of the parties' profits is 7rs + 7rb = (v/16)(1 + k)(2 -k) which has a maximumof (9/64)0. So ) and B( ).) 2 v. the range of "serious"offers is bounded from below by max[S(vL).k)2(1 + k) which c) i) The seller's expectedprofit is 7rs(k) is strictly decreasingin k. We have the following results: a) The equilibriumoffer strategies.then B(vb) = S(&. then S(vs) . the pair S( ) and B( ) of Theorem 2 describeclass A equilibria except at boundaryconditions that occur as follows: THEOREM 3. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions .842 Chatterjee and Samuelson zero profit equilibrium. Example 1. boundaryconditionsare: If B(vb)> S(&. If B(Cb) > S(U). it is possible to construct other equilibriainvolving discontinuous offer strategies that place probabilitymasses on specific offer values. B(Lb)1 Thus. at k = 1/2. the buyer would earn negative expected profits against the seller's best response. then B(Vb) C B(O) for Vb < S(vs).44 on Thu.).170.6. 9/32. b) The probability that a bargain is reached equals (-k2 + k + 2)/8 and achieves it maximumvalue. and from above by min[S(os). By simple inspection one can check that linear offer strategies above constitute solutions of Equations 3a and 3b when both distribution This content downloaded from 158. at k = 1/2. In 1) 2) 3) 4) a class A equilibrium.even the linked differential equations of Theorem 2 resist analytic solutions for all but the most elementary distributionfunctions.) for Vb> Bl(S(Os))If B(Ob)< S(s). For instance.k) which is strictly increasing in k.k)/2) 0.If this restriction failed to hold. then S(v8) = B(Vb) for vs < S (B(Qb))If B(vb) <S(gs). this by no means exhausts the set of all equilibrium solutions. We begin with an examination of "identical" bargains-cases in which Fs( ) = Fb( ).k) + ((1 . In sum. are given by: S(v8)= vs/(2 . The examples that follow are limited to distributions belonging to the uniform family. Furthermore. Suppose the parties bargain under the sealed offer rule with Fs(v) = Fb(v) = v/v.k)/2)v for 0 c v. = (0/48)(2 . ANALYSISOF SPECIALCASES While Theorems 2 and 3 characterizeequilibriumstrategies that are well-behaved. IB(b)] 3. < ((2 S(v.S(vs) for Vs> B(Ob).

For easy reference.44 on Thu.Bargaining UnderIncompleteInformation 843 functions are linear.) Similarly. An identical bargain (k - Y/2). offer strategies." The combination of linear distributions. k = 1/2.Regardless of the specific rule.The buyer "shades"his offer below his true reservationprice except when the probabilityof a bargainjust becomeszero. the buyerstrategy intersects the 450 line precisely at the seller's lowest offer. however.6.the optimal seller strategycalls for a "mark up. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . Once the equilibriumstrategies have been established. split-the-difference rule. the results in parts b and c follow from straightforward computations. and bar- This content downloaded from 158. Figure 1 plots the equilibriumstrategies for the 12 10 - ~ ~ ~ ~ ~ ~ 9 8 1 891 11 I I I L I I | I | I I _ _ _ VsVbs V Figure 1.170. Note that part c describes each player's ex ante profit prior to the "draw" of either reservationprice. the equilibriaof Example 1 satisfy a number of general properties. point B is level with point A. (In Figure1.

furthermore. and it treats the parties symmetrically. = Fb)and. To put this another way. Should not the switch signify an increase in profit for the seller and a reductionfor the buyer? The answer is no. A bargain is possible provided vs < Vbbut will only be concluded when s c b.A suggestion is made to change the rule to k = . When k increases. The maximumattainable probabilitywhen optimal offer strategies are used is 9/32. ((2 - k)/(1 + k))vb - ((1 - k)(2 . as the formulas of Example 1 demonstrate. Suppose that vs is uniformlydistributedon the interval [0.e. the seller moving closer to his reservation price. Myerson and Satterthwaiteshow that the split-the-differencebargainingrule is an optimal mechanism-that is. In this instance. expected groupprofit under truthful offers is 1/6..844 and Samuelson Chatterjee gaining rule imply that the buyer's (seller's) conditional expected profit increases (decreases)as the square of his reservationprice. Suppose that the bargaining rule is k 1/2.both the buyerand the seller shade their offers. It is true that the seller would gain and the buyer would lose if the strategies employed for k = 1/2were continued to be used for k = 3/4.s ! 0). Example2. One conclusion of Example I is that one's intuitive notion of who gains from different kinds of compromises can be mistaken.6. the probability of a successful bargain would be 1/2 if both parties made truthful offers (since F8= Fb). or when vs.170.In fact. It is efficient (i. using the results in part a. the bargaining rule that calls for splitting the difference (k = 1/2) has a natural appeal. Since a sale is made only when there is some "bargaining space" between the two offers (i. Similarly. the move would seem to signify a surrenderof this space by the buyer. it maximizes expected groupprofit).The net result is to confer an advantageon the buyer. the bargain is identical (F. This content downloaded from 158.the probability distribution is symmetric.e. it attains the greatest group expected profit of all possible bargaining procedures.under the equilibriumstrategies it is at most /64.k)/2(1 + k))o. the buyer toward a greaterunderstatement. is such a change? It would appearat first blush that this change benefits the seller and harms the buyer./4 so that the sale price is determined according to P = (3/4)b+ (1/4)s.44 on Thu. buyer or seller.. The employment of shading and mark up strategies in equilibrium precludessales in many circumstanceswhen mutuallybeneficialbargains exist. The fallacy of this line of reasoning is that it implicitly assumes that the bargaining strategies are unaffected by the rule change. This is not the case. however. The next example characterizes the equilibriumstrategies for nonidentical bargainswhen the buyer and seller distributionsare uniform.For these reasons splitting the difference between offers is attractive for bargainsthat are identical and symmetric. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . In Example 1. when b .In whose interest.

the seller on averageis worse off than before.e.k)/2(1 + k))Vb for 0 vs < ((2-k)/(l + k))Vb -((1 - k)(2 . Figures 2 and 3 illustrate a pair of typical equilibria. A number of points concerning the efficiency of the sealed offer bargainingrule can be summarized. When the dis- This content downloaded from 158. and Ub imply larger (or no smaller) buyer and seller offers-that is. if the seller becomes more uncertain about the buyer's value (such that Avb = -_AVb > 0).170. Other things equal. For instance.k)/2) Vs < Os b) The equilibrium offer strategy of the buyer is specified by: B(vb) < Vb/(l + k) + (k(l .First.Os. Furthermore. Ub]. he makes higher (lower) offers than before when he holds sufficiently large (small) reservation prices).k)/2)Ob k) + (k(l < - k)/2(1 + k))Ob ((1 + k)/(2 - for B(Vb) = ((1 - k)/2)bb Vb < k))vs + ((1 - k)/2)Ob Vsl/(1 .k) + ((1 -k)/2)Vb for ((1 + k)/(2 - k))Os + ((1 - k)/2)Ob < Vjb < Vb The offer strategies are sensitive to changes in the underlying distri- butions in the natural way. increases in Vb.44 on Thu. the range of his offers increases in equilibrium(i.k)(2 .k)/2)bb Ub < S(vs) > vs(2 .k)/2(1 + k))bb < s - ((2 . with the increase in uncertainty.k)/2)Ob - for ((2 - k)/(l + k))Vb ((1 . 845 : Ob.6.k)/2(1 +k))Vb for 0 c B(vb) = Vb/( + Vb < ((1 . a shift to uniformlyhigher possible buyer or seller reservationprices (in the sense of stochastic dominance) results in higher offers.k) + ((1 k)/2)Ob for ((2 . 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . As a second example consider a player's offer response to a mean preserving spread in the distributionof his opponent'sreservationprice. in the nonidenticalsetting the rule of thumb of splitting the difference between offers will no longer maximize expected group profit (except coincidentally).a simple calculation shows that.k)/2(1 + k))Vb S(v) =v -(2 -k) + ((1 .where 0 c Vb c Os Then we have the following results: a) The equilibriumoffer strategy of the seller is specified by: S(Vs) = vb/(l + k) + (k(l . An analogous result holds for an uncertain buyer.Bargaining UnderIncompleteInformation 0s] and that Vbis uniformlydistributedon [tb.

Lb. consequently.6.k profit (since the seller offers s = Vbwhen vs . 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . Clearly then. Vb). and Vb. the seller and buyer obviously play asymmetric roles. suppose there is no uncertainty surroundingthe buyer's reservation price. Here. the bargaining rule that maximizes group profit must be determined on a case-by-case basis. a number of mutually beneficial bargains will be missed. In short. a tedious but straightforward calculation can confirm that the This content downloaded from 158. a seller's first offer is superior to any other bargaining rule.44 on Thu. Nonidenticalbargain.846 Chatterjee andSamuelson tributions FS() and Fb() differ. Second. The bargainingrule that calls for the seller to make the first and final offer (k = 0) extracts 100% of the potential group Vb Seller / * O~~~vb ~~"s VSVb v Vb b 1/2. Figure 2. vs.But a buyer who makes a first and final offer (k = 1) will shade his offer below his true value.170. To take an extreme case. the expected group profit as a function of the bargaining rule k will vary with vs.

(I1-k) s)gb(s) ds = O.170.6.vs) and Ub(Vb .k = 1/2.(P . earn von Neumann-Morgenstern utilities u. Suppose that the seller and the buyer. Then it is easy to check that the new first order conditions are -b Ub(Vb- b) -k Ub(Vb- kb .Vb Figure 3. l b Sel ler X Buyer 0 Vb VS I Vb VS. This content downloaded from 158. Additional insight into the nature of the bargaining equilibriumcan be gained by relaxing the assumption that the bargainers are risk neutral. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . Player Risk Aversion. Vb s.UnderIncompleteInformation Bargaining 847 expected profit of the seller (buyer) is decreasing(increasing)in k.P) in the event of an agreement and zero utilities otherwise. respectively.44 on Thu. continues to hold for nonidentical uniformly distributedbargains. which held in the identical bargainexample. Nonidentical bargain. This result.

1]. however. and the buyer's intercept is smaller than the seller's. This fact leads risk-averse bargainers to make offers closer to their true values than their risk-neutralcounterparts.e.1/2f3)/(4f2 - 1) + [1 (1/2f)]vb where A = 21/a -1/2. Not surprisingly. b 2 s if and only if Vb vU. potentially beneficial bargainswill be lost.the marginalincrement in profit associated with a slighty more agressive offer (a higher seller offer or a lower buyer offer) is weighted less heavily than the possible loss. the equilibrium strategies approachthe strategies s = vs and b = Vb for all vs and Vb.44 on Thu.the underlyingdistributionsare both uniformon [0. suppose the players have the same degree of risk aversion. an agreement is precluded (b < s). In this symmetricexample.vs) -(1-k) andSamuelson Chatterjee f us(kb + (1 - k)s - vs)gs(b)db = 0.6.In the limit as a approaches0 (i.170. Consider the effect on the bargaining strategies as the players become increasinglyrisk averse:As a decreases. the offer strategies have the same slope. an increase in the risk aversion of the seller (buyer) implies uniformly lower (higher) offers by both parties in equilibrium. we can present equilibriain the case that: 1) the players' utility functions display constant relative risk aversion. With these expressions. one can show that. and 2) the underlyingdistributionsare uniform. other things equal. In the case of differing degrees of risk aversion. and the bargaining rule is k = -( 1/2. if as a result of the change. where 0 < a < 1. 4. The result is generally lower seller offers and higher buyer offers. it is well to examine the extent to which the model'sassumptions captureor approx- This content downloaded from 158. Short of this extreme case.848 and uS(s . u(y) = ya. with risk aversion.As a simple illustration. U and so all mutuallybeneficial agreementsare attained. The intuition underlyingthis result is that.Then the equilibrium strategies are linear: 1/2)/(2f2 _ 1/2) + S= [1 -(1/2f)]vs - b = (1 . the players become infinitely risk averse). : increases causing the slope of each offer strategy to increase (and the intercept to fall). 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . Consequently. CONCLUDING REMARKS In what respects do the equilibria described in Theorems 2 and 3 provide an accurate representation of bargaining under uncertainty? Since the conclusions of any model depend on its premises.the opponent's best response to more truthful bids by the player who has become more risk averse is to make more aggressive offers himself.

the constant offers S(v. Additionally. While the single-stage bargaining rule fails to capture the pattern of reciprocalconcessions observedin everydaypractice. As a simple example.) = B(vb) = 0. it is a useful idealization and a starting point for other investigations. when a bargain is unsuccessful at the initial stage. see Sobel and Takahashi [1980].6. (For an example. 0. each party could revise his probability assessment of the other's reservation price and could make a concession in his next offer.5. the better he can expect to fare in the negotiations. In this case. supposethe buyer'sreservation price is uniformly distributed on the interval [0. For example.44 on Thu.UnderIncompleteInformation Bargaining 849 imate the actual bargainingconditions.each player must estimate his opponent'svalue and his own value in the event there is an agreement or not. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . Indeed.170. These kinds of multistage bargains can be properlyanalyzedwithin our frameworkand deserve further attention." Accepting this principle and believing firmly that any bargainingopponent will accept it as well.the fact that the players would conclude an agreement (or not) is informativeof the good's ultimate value.5]. uncertaintyconcerningthe opponent's walk away price is frequently encountered in bargaining situations. For instance. suppose that each bargainer's value for the good depends on future (unknown) market conditions as well as on his personal characteristics.) In our view. Then. the higher the buyer's value the more he is willing to offer. one would expect agreements to become more frequent. 1] and the seller's price is similarly distributed on the interval [0.5 constitute an equilibriumand guar- This content downloaded from 158. the better the bargainer's information about his opponent. It is the task of each bargainerto assess the likely reservation price of his opponent. An individual is likely to accept the following proposition as reasonable:"The higher the seller's value the more he demands for the good. First. In particular. there are strong arguments for the monotonic equilibria of Theorems 2 and 3 even when other equilibriamay exist. A more general model would allow the bargainersmultiple rounds in which to exchange offers (potentially incurrng "transaction"costs in the process). Monotonic offer strategies may also provide a focal point for the bargainingprocess. the individualthen seeks a best monotonic offer strategy. based on this information. To the extent that the exchange of offers conveys information about the reservation prices. suppose that each bargainer possesses differential information bearing on the good's potential value. Probabilityassessment becomes more complicatedin an environment with stochastic dependence between the player values. For instance. the man on the street is better equippedto bargainwith a car dealer if he possesses the "book"that lists the prices the dealer himself has paid for various models and if he has assessed the current state of demand for automobiles.

This response is consistent with the expectation that such a shift should benefit both parties (not just the buyer).5. It is unusual for the buyer to be the only potential customer for the good or for the seller to have a monopoly position. however.170. If. at least partially. players will adopt monotonic strategies because they are more efficient. In short. One must not overlook. In most bargainingsituations. both parties make offers that are smaller than 0. one would expect such an opportunityto minimizethe gap This content downloaded from 158.) = B(vb) = 0. 5] instead of [0. it is prudent for a buyer who values the good highly to make a generous offer. the existence of a second equilibrium in monotonic strategies. however.Indeed.5. Each party chooses not to push further its demand. In this case of a "close"bargain. Nevertheless. In this instance. 11. The employment of an aggressive offer will likely preclude an agreement. while an offer making too great a concession will be unprofitable. Thus. the buyer's value is drawn uniformly from the interval [0. the constant strategy equilibriumS(v. expecting his opponent to feel the same way. In this case.5 for sufficiently low reservation prices and offers greater than 0. With the shift in possible buyer values. while the constant strategy equilibriumis not. To the extent to which beliefs about the prices available from third parties transactions differ. there is no guaranteethat a mutually beneficial agreement is always available. Finally.850 andSamuelson Chatterjee antee that the players always concluded a bargain. the price (net of search transaction costs) that he could expect to obtain elsewhere. the reservationprices of the buyer and seller will diverge. or access to these parties differs. thereby increasing the likelihood of an agreementwhen facing a seller who may not cooperatewith an offer of S(v. = Fb points out the main difficulty with a constant offer strategy. each party's reservation price will reflect. the offers of the buyer become more generous and those of the seller more demanding. Observe. that the monotonic equilibrium is responsive to changes in the underlying distributions FS and Fb. when Us> Qb.) = 0. We would argue that close bargains occur most frequently in actual practice.5. the opportunityfor the seller or the buyer to cease negotiations and to considera third-partytransaction is available. The monotonic equilibriumis free from these criticisms since it depends explicitly on the underlying distributions.5 becomes much less compelling.there is no constant strategy equilibrium.the case of an identicalbargain F. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions .5 for high prices. Equilibrium theory can furnish no definitive conclusion indicating which outcome represents the "more logical" bargaining focal-point. Is this a logical resting point-a position from which neither player expects the other to retreat? It would seem that the buyer could be expected to concede (settling for a smaller but still substantial profit) if the seller insisted. at least implicitly.44 on Thu.6.nor to retreat. for instance.

P. The Economicsof Bargaining. SATTERTHWAITE. A. B. First-OfferBargains. ANDR. 1969. J.Econometrica CRAWFORD. 602-637.. J. 1980. Takao Kobayashi. ROTH. 159-182.. ACKNOWLEDGMENT We would like to thank Jerry Green. Bilateral Trading. bridge. 1982. Econ. The Strategy of Conflict. Agreeingto Disagree."Discussion Paper 469S. 1960. R. J. V. 1978. W. R. 1236-1239. P80P106. C. of Illinois Press. SAMUELSON. sion Paper 80-25. New York.Basic Books. J. R.6. 1950. 1976. DiscusSOBEL. R. A Theory of Disagreementin Bargaining.170. 1972.Econometrica HARSANYI. CROSS. 0. 26.Ann. Ill. B. G.Econometrica18. 151-162. J.Mgmt. SELTEN. Person BargainingGames with IncompleteInformation. Sci. 1980.Mass. This content downloaded from 158.44 on Thu. 155-164.J. 14.R. HARSANYI. 486-502.San Diego. E. CamSCHELLING. 321-334. The BargainingProblem. Approachesto the BargainingProblem Before and After 24. Sci.Springer-Verlag. Arbitrationof Two-Party Disputes underUncertainty. Mgmt.University YOUNG. University of California. and John Pratt for helpful comments and especially HowardRaiffa for suggesting the problem. W. Rev. 144-157. TAKAHASHI. Statist.)1975. 4. MYERSON. 1979. Studies 45. J. AND M. the Theory of Games. 50. T. A GeneralizedNash Solution for TwoHARSANYI..Bargaining: FormalTheoriesof Negotiations.Information UnderIncomplete Bargaining 851 between the possible reservationprices of the parties. ANDI.AxiomaticModelsof Bargaining. Games with Incomplete Information Played by Bayesian Players. 1956. 21 Nov 2013 15:46:27 PM All use subject to JSTOR Terms and Conditions . ROSENTHAL. Efficient Mechanisms for MYERSON. C.Sci. A Multi-Stage Model of Bargaining.Mgmt. Incentive Compatibilityand the Bargaining Problem. C. (ED. Champaign-Urbana. C. NorthwesternUniverstiy. This suggests that close bargains may be of the greatest practical importance. Econometrica 47. 1981. 1979. 18. 1967-1968. NASH.HarvardUniversity Press. REFERENCES AUMANN. 595-604. 61-73.