CHAPTER 15

BARGAINING AND NEGOTIATION

The following table shows the three topic sections of this chapter and the associated study
guide problems that pertain to each topic section.
Section Topic
1 The Economic Sources of Beneficial Agreements
Problems M1-M10, S1-S5, L1-L2.
2 Multiple-Issue Negotiations
Problems M11-M14, S6-S7, L3-L6.
3 Negotiation Strategy
Problems M15-M20, S8-S10, L7-L10.

Multiple Choice

M1 The minimum value a seller sets for a transaction is referred to as its

a. Implicit price.
b. Acceptance price.
c. Reservation price.
d. Sale price.
e. Market price.

M2 The size of the zone of agreement is the

a. Difference between the buyer and the seller reservation values.
b. Difference between the seller’s and buyer’s profit.
c. Sum of the sale price and the seller’s profit.
d. The sum of the players’ reservation prices.
e. The average of the player’s reservation prices.

M3 The parties’ profits from transactions can be represented graphically by the

a. Transactions curve.
b. Profit curve.
c. Zone of agreement.
d. Reservation-price graph.
e. Payoff frontier.

M4 A negotiated agreement is efficient if

a. It is superior to at least one other possible agreement.
b. The sum of the buyer’s and seller’s profit shares is exactly 100 percent.
c. It is thought to be fair.
d. No other agreement exists that would make one party better off without making
the other worse off.
e. Both parties benefit relative to their disagreement options.
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M5 A distributive bargain is one is which

a. Total profits are evenly divided between the parties.
b. Each party bargains for a share of total profits.
c. Arbitration determines the distribution of total profits.
d. The parties can make tradeoffs among multiple issues.
e. The parties agree to bargain in good faith.

M6 An out-of-court settlement is mutually beneficial if

a. The sum of the parties’ court costs is smaller than the difference between their
expected values from litigation.
b. The sum of the parties’ court costs is greater than the difference between their
expected values from litigation.
c. The sum of the parties’ court costs is greater than the sum of their expected values
from litigation.
d. The difference between the parties’ court costs is greater than the difference
between their expected values from litigation.
e. The parties disagree on the expected value of going to court.

M7 The prospect for a mutually beneficial agreement is created by

a. Litigation costs.
b. Differences in the parties’ values.
c. Differences in the parties’ probability assessments.
d. Similarities in the parties’ values.
e. Answers a, b, and c are all correct.

M8 If the expected litigation value for each firm is $100,000 and the parties’ court costs are
$15,000 and $10,000 respectively, then the size of the zone of agreement is
a. $90,000.
b. $85,000.
c. $25,000.
d. $75,000.
e. No zone of agreement exists.

M9 A plaintiff (Firm Z) is suing a defendant (Firm X) for patent infringements. Both sides
estimate that if the suit is upheld, the damage award will be $1.5 million. Firm Z
estimates its probability of winning to be .7 with court costs totaling $450,000. Firm X
estimates its probability of winning at .7 with court costs totaling $700,000. Therefore,
a. The plaintiff’s minimal acceptable settlement receipt is $550,000.
b. The defendant’s maximum acceptable payment is $1,150,000.
c. The plaintiff’s minimal acceptable settlement receipt is $1,050,000.
d. No zone of agreement exists.
e. Answers b and d are both correct.
 Bargaining and Negotiation Chapter 15

M10 In an efficient agreement,

a. Risk-averse partners should share the risks of uncertain outcomes.
b. The Risk-neutral partner should bear less of the risk.
c. Risk sharing is typically unnecessary.,
d. The risk-neutral party should bear all of the risk.
e. Answers a and d are both correct..

M11 Company A is seeking to acquire Company T. Under its current management, the value
of company T is $50 per share or $80 per share depending on whether it finds oil in its
most promising Alaskan field. Company T judges the chances to be 50-50, but Company
A judges the chance of an oil strike at only 30%. Company A estimates that synergies will
increase T’s value by $15 once taken over and placed under A’s management.
a. A mutually-beneficial acquisition at a fixed price per share is possible.
b. A mutually-beneficial acquisition at a fixed price per share is not possible.
c. An acquisition calling for a contingent price per share is possible.
d. Answers a and b are both correct.
e. Answers a and c are both correct.

M12 An efficient agreement for a quantity-price contract can be achieved by

a. Maximizing the sum of the players’ payoffs
b. Minimizing price and maximizing quantity.
c. Maximizing the quantity of output traded.
d. Setting a reasonable quantity and then haggling over price.
e. Having the seller name his price and the buyer decide the purchase quantity.

M13 A buyer’s value for purchasing a summer house and 5 acres of surrounding land is
$270,000, while the seller’s value is $300,000. Letting the seller retain 2 acres of the land
is worth $100,000 to the seller but reduces the buyer’s overall value by $60,000. Having
the seller clear trees from the land before the sale (to allow a view of the lake) is worth
$30,000 to the buyer and costs the seller $10,000. (A conservation restriction prevents
any new owner from cutting the trees.) An efficient, value-maximizing deal
a. Is not possible. There is no zone of agreement.
b. Means selling the house and all the land.
c. Means selling the house and just 3 acres and clearing the trees.
d. Means selling the house and all the land and clearing the trees.
e. Means selling the house and just 3 acres.

M14 A supplier can deliver a compound that is 97% pure, 98% pure, or 99% pure. A buyer
values these compounds at $1,000, $1,500, and $1,800, respectively. Raising purity by
each 1% increases the supplier’s cost by $600. An efficient agreement calls for
a. 97% purity, assuming an agreement is possible.
b. 98% purity, assuming an agreement is possible.
c. 99% purity, assuming an agreement is possible.
d. 100% purity
e. In this case, no agreement is possible.
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M15 When operating under perfect information, bargainers

a. Should usually reach efficient agreements.
b. Still are unsure about the zone of agreement.
c. Can never reach an equilibrium outcome.
d. Will frequently fail to achieve any agreement.
e. Should find it easy to reach equitable agreements.

M16 Under imperfect information, bargainers

a. Always reach efficient outcomes.
b. Behave the same way as they would under perfect information.
c. Rarely reach efficient agreements.
d. Usually reveal true values at the outset of negotiations in order to reach an
efficient agreement.
e. Behave strategically causing some mutually beneficial agreements to be missed.

M17 You own a sports car (which you value at $50,000) and have been negotiating with a
serious buyer. You’ve decided to announce a take-it-or-leave-it price. You are certain that
the buyer will accept a price of $70,000. If you demand $90,000, you predict a .7 chance
of acceptance.
a. Demand $90,000. This price maximizes your expected profit.
b. Demand $90,000. This price maximizes your expected profit.
c. Demand $70,000 provided that you are sufficiently risk averse.
d. Demand $70,000. This price maximizes your expected revenue.
e. Answers a and c are both correct.

M18 The phrase “waiting the other player out” refers to

a. Letting the opponent make the first offer.
b. Engaging in purely cooperative behavior.
c. Only agreeing to terms once the other bargainer has made full concessions.
d. Being a self-interested bargainer.
e. “Putting one’s cards on the table.”

M19 Two sides are bargaining to reach a resolution of a long-running dispute. One disputant is
threatening to take an action that would impose a cost of $100,000 on the other, but also
mean a cost of $50,000 to itself. Such a threat is
a. Irrational, because it is mutually harmful.
b. Rational, because the threat maker suffers the lesser cost.
c. Strategic, because it might favorably affect the terms of an agreement.
d. Irrelevant, because it will never be carried out.
e. Probably not worth the cost.

M20 If a pair of parties repeatedly interact over time,

a. The frequency of disagreements is likely to increase.
b. Purely opportunistic behavior is less likely to occur.
c. The weaker bargaining party will make greater immediate concessions.
d. There behavior is the same as under one-shot bargaining.
e. Answers a and c are both correct.
 Bargaining and Negotiation Chapter 15

Short Problems and Questions

S1 Determine the total possible gain (that is, the sum of the agents’ profits) when a seller’s
and buyer’s reservation prices are $5.7 million and $10.3 million, respectively. What if
they are $125,000 and $96,000, respectively. Will a zone of agreement always exist?

S2 Is bargaining a zero-sum game? Explain.

S3 Firm A is suing Firm B. Determine the range of out-of-court settlements when the
expected value of litigation for the two firms is $120,000 in favor of Firm A. The court
costs for Firm A and Firm B are $40,000 and $30,000, respectively.

S4 In a lawsuit, a small firm and a large firm both estimate a damage award of $70,000 in
favor of the former if the small firm wins the case. If the large firm wins, it will owe no
damages. Each side believes that it has a .7 chance of winning. The court cost for the
small firm is $30,000 and $20,000 for the large firm. Might the small firm accept an out-
of-court settlement of $35,000? Why or why not? Explain.

S5 What role does risk play in negotiations? Explain.

S6 How does the Coase theorem (Chapter 11) relate to bargaining and negotiation? Explain.

S7 Determine the value-maximizing order quantity when the buyer’s value from purchasing
Q units of output is: B = 25Q - .5Q2, and the seller’s cost of producing Q units of output
is C = 2Q2.

S8 Describe factors that might cause the bargainers to fail to reach efficient agreements.

S9 “By nature, a bargaining situation must be purely competitive since each side is trying to
capture as much of the total share of profits as possible.” Comment.

S10 Why might one party to a negotiation try to take an extreme position at the beginning of a
series of offers? Is this rational?

Longer Problems and Discussion Questions

L1 A business major is contacted by a fellow student about tutoring. The student seeks five
hours of lessons per week, and has decided that he will be willing to pay up to, but no
more than, $10 per hour for the lessons. The business major is currently working for the
college financial services office five hours per week for $6 per hour. Accepting this job
means quitting the finance office job.
a. Will the two students be able to reach a mutually beneficial agreement? Explain.
b. If the answer is yes, indicate a possible price, and show how the agreement will
benefit each student.
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L2 a. Determine the range of out-of-court settlements for Firms A and B when the
expected value of litigation for both is $500,000 in favor of Firm A. The court
costs for A and B are $75,000 and $100,000, respectively.
b. What does the range calculated above mean?
c. How would the range be affected by introducing conflicting assessments?
Specifically, suppose each side believes its own winning chance is 60 percent.

L3 You and your spouse have been house shopping for some time. After viewing a particular
house, you are less than impressed, but your spouse is excited. The more you talk about it,
the less interested you are, but you perceive that your spouse is even more interested than
before. How do you resolve this conflict?

L4 The developer of a shopping mall is negotiating with a retail store about the terms of a
prospective lease. The lease has 8 different clauses. Unfortunately, on each clause, the
sides interests are directly opposed. For instance, the store wants to display a large sign;
the developer strongly prefers a modest sign. The store wants the right to terminate the
lease after 4 years; the developer opposes such a termination.
“Because the interests of the parties are universally in conflict, they are faced
with a purely distributive negotiation. Which side gets its way on a given
clause isn’t a matter of efficiency, but is only a matter of distribution of gains.”
Do you agree or disagree with this statement. Explain.

L5 A builder and a couple are negotiating a contract to renovate the couple’s house. A
“high” quality renovation is worth $100,000 to the couple and will cost the builder
$80,000 to complete in 8 weeks. A “medium” quality renovation is worth $75,000 to the
couple and will cost the builder $45,000 to complete, also in 8 weeks. The builder could
finish the job sooner (in as few as 4 weeks), but each week saved means an additional
$4,000 in building costs (due to overtime and rush orders). Thus, the builder’s profit is:
P – [(4,000(8-w) + Base Cost],
where P is the price the couple pays the builder, w is the completion time in weeks, and
the base cost is $80,000 or $45,000. For instance, if the builder receives $110,000 to
complete a high-quality renovation in 6 weeks, his profit is 110,000 – (8,000 + 80,000) =
$22,000. In turn, the couple’s consumer surplus is given by:
Value + (2,000)(8w – w2) - P,
where the couple’s value is $100,000 or $75,000. Note that if w = 8 weeks, the second
term is zero (there is no effect on value). If w = 6 weeks, the second term is $24,000; that
is, the couple’s value increases by $24,000 for a job completed two weeks earlier than
normal.
a. An efficient contract maximizes the total profit of the two parties together. Write
down the expression for this total profit. Note that the total profit sum does not
depend on the payment P. Does an efficient contract call for a high-quality
renovation or a medium-quality renovation? Explain.
b. In an efficient contract, what is the optimal value of w? (Hint: Determine w* by
maximizing the total profit expression you found in part a.)
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L6 “Flip-flopping” on issues has become quite common among elected officials – both when
presenting their positions to interest groups and when voting on legislation. In terms of
negotiation strategy, does flip-flopping make sense? Explain.

L7 In August 1990, Iraqi forces invaded Kuwait. In January 1991, Allied forces began an air
campaign to force Iraq to withdraw. In March, after a 100-hour blitzkrieg campaign, Iraq
agreed to withdraw from Kuwait. Use bargaining theory to explain why the war was
fought, and why Iraq withdrew after the bombing instead of before.

L8 Recently, a major airline filed for Chapter 11 (bankruptcy) after a prolonged strike. This
would not appear to be in the best interests of both the owners and the union negotiators.
How might uncertainty have led to such an outcome?

L9 a. For many years, the United Auto Workers bargained with the big three auto
companies to arrive at industry-wide labor agreements. The union would bargain
and reach contract terms with one of the companies, and the others would adopt
similar or identical agreements. Is such an approach rational? Explain.
b. Anecdotal evidence from the auto industry is that when the union wanted a money
issue (such as wages, or better retirement funding), it would bargain with GM, but
if it sought a social item (e.g., safety), it would bargain with Ford. Is such an
approach rational? Explain.

L10 Discuss the differences between one-shot bargaining situations and repeated situations.
Do the settings call for different bargaining strategies?

SOLUTIONS

Multiple Choice
M1 c
M2 a
M3 e
M4 d
M5 b
M6 b
M7 e
M8 c
M9 b
M10 e
M11 d
M12 a
M13 c
M14 a
M15 a
M16 e
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M17 e
M18 c
M19 c
M20 b

Short Problems and Questions

S1 In the first case, the total potential trading gain is $4.6 million. In the second case, there is
no zone of agreement, and so no trading gains are possible. In general, a zone of
agreement exists only if the buyer’s reservation price is greater than the seller’s.

S2 No, most (if not all) bargaining is actually a non-zero-sum game, in that there are possible
mutual gains for both (or all) parties to the negotiations.

S3 Any settlement between [120,000 - 40,000] and [120,000 + 30,000] is mutually

beneficial. Thus, the range is $80,000 to $150,000.

S4 The range of out-of-court settlement extends from [(.7)(70,000) - 30,000] to

[(.3)(70,000) + 20,000], that is, from $19,000 to $41,000. Thus, the small firm might well
accept a $35,000 settlement.

S5 The presence of uncertainty or risk matters in several ways. First, uncertainty makes
negotiated agreements harder (or sometimes easier) to achieve since the parties may have
different assessments of the value of the transaction. Second, the presence of risk means
that the parties may benefit from structuring optimal risk-sharing contracts and contingent
contracts. (A risk-averse bargainer will measure his or her reservation price according to
its certainty equivalent.)

S6 The Coase theorem states: “Bargaining between the affected parties will result in an
efficient outcome, regardless of the initial property rights assignment.” (The Coase result
holds provided that the cost of bargaining is minimal and provided that the parties have
adequate information about each other’s preferences.) Although the theorem was applied
in the context of externalities, this result can be viewed as relating to any bargaining
situation in which the parties can make a mutually beneficial agreement.

S7 To find the value-maximizing output, we maximize total net benefits (B - C) by setting

MB = MC. We have MB = dB/dQ = 25 - Q and MC = dC/dQ = 4Q. Setting these equal
implies Q = 5 units.

S8 Factors that might lead to bargaining failures include: conflicting (i.e., optimistic) value
assessments, different concepts of what is equitable, strategic behavior under imperfect
information, and misjudging the other side’s intentions.

S9 The quotation is incorrect. Even though there is competition over profit distribution,
cooperation is needed to attain an agreement in the first place.
 Bargaining and Negotiation Chapter 15

S10 It may be rational if the party seeks to obtain the maximum gain from the transaction. By
taking an extreme position, it seeks to frame the negotiation “dance” in its favor. It can
appear to meet the other party halfway on an issue, and still obtain a substantial share of
the net gain from the settlement.

Longer Problems and Discussion Questions

L1 a. Yes, the zone of agreement is between $6 and $10 per hour.

b. For example, a price of $9 implies a profit of 9 – 6 = $3 per hour (or $15 per
week) for the business major. In turn, the student’s consumer surplus is 10 – 9 =
$1 per hour (or $5 per week). Regardless of the exact negotiated price, the total
profit from an agreement is: 10 – 6 = $4 per hour (or $20 per week).

L2 a. The range is between $425,000 and $600,000.

b. The range shows the set of possible out-of-court settlements that would be
mutually beneficial. The length of the range, $175,000, measures the total gains
from an agreement.
c. If each side sees its winning chance at 60%, Firm A’s minimally acceptable price
is (.6)(500,000) - 75,000 = $225,000. The maximum amount that Firm B is
willing to pay is (.4)(500,000) + 100,000 = $300,000. In this case, the zone of
agreement (and total gains) has shrunk to $75,000.

L3 As always, the objective of the decision maker is important. There is no single “right”
answer. However, to preserve a relationship (or a marriage), individuals may have to
accept some things they otherwise would reject.

L4 Though superficially appealing, the statement is incorrect. Even though the parties’
interests are strictly opposed issue-by-issue, efficiency still depends on the relative values
the sides place on the issues. A clause that one side values highly while the other cares
little about should be decided in favor of the first side; the dollar benefit gained by that
side is much greater than what it costs the other, so the net value of the deal will increase.
Thus, in order to maximize the total value of the “pie”, each side should “win” the issues
it values relatively highly and should relent on the issues it cares little about.

L5 As noted in the text, vote swapping (or so-called log rolling) may be mutually beneficial
for legislative members seeking to achieve winning voting coalitions on those issues that
are of greatest importance to them. Similarly, an elected official in front of a particular
audience might be inclined to “compromise” his true position in the direction of the
audience’s position, i.e. tend to say what the audience wants to hear.

L6 a. The total profit sum is: Couple’s Profit + Builder’s Profit =

[Value + (2,000)(8w – w2) - P] + [P – ((4,000(8 - w) + Base Cost)] =
[Value – Base Cost] + [16,000w - 2,000w2 – 32,000 + 4,000w] =
[Value – Base Cost] + [20,000w - 2,000w2 – 32,000].
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We see that the payment P is simply a transfer that distributes profit between the
sides but does not affect the profit sum. The medium-quality renovation is
efficient. It implies a total gain of $75,000 - $45,000 = $30,000, which is greater
than the total gain from a high-quality renovation ($20,000).
b. We seek w that maximizes  = 20,000w - 2,000w2 – 32,000. Thus, we set d/dw
equal to zero: 20,000 – 4,000w = 0, or w = 5 weeks. For instance, a contract
calling for a medium-quality renovation, completed in 5 weeks, at a price of
$81,000 provides a profit of $24,000 to the builder, and consumer surplus of
$24,000 to the couple. (Be sure to check these calculations.) The maximum total
profit is $48,000.

L7 The war began (apparently) as a misunderstanding and/or misperception regarding U.S.

intentions in case Iraq determined to settle a border dispute with Kuwait by force. Signals
indicating U.S. resolve were not sent, or were not received, or were misinterpreted.
Iraq might have withdrawn earlier, but apparently believed that the Allied powers
would not mount the air campaign that did develop, or that Iraqi forces could withstand
the campaign, or that the air campaign would prove to be far more costly for the Allies
than it was, in which case it would have been halted prior to forcing Iraq to leave. As it
became clear that the Allies had every intention of pursuing the war and Iraq had nothing
to gain by continuing (and much to lose), settlement was reached.

L8 A costly strike could have been caused by a number of factors: differing assessments by
the parties of the relative costs of a strike, misjudgment of the other’s intentions, and
reputation concerns, among others.

L9 a. Yes, industry-wide bargaining is advantageous for the union. Industry-wide

bargaining prevents companies from fragmenting the union effort. The union
becomes a monopsonist (single seller), with maximum power. It is less clear that
the approach is rational for the companies, but they may not have much choice.
It should be noted that if a financially strong company signed the agreement,
and the others were forced to follow, then the smaller (weaker) companies might
be forced out of business, or at least be strained to meet the agreement.
b. Yes. Presumably GM, as the largest company, had more financial resources than
the other two companies, which would increase the zone of agreement on
monetary issues. Presumably Ford had a greater “social conscience,” which would
increase its zone of agreement on social issues.

L10 For a complete answer, refer to the discussion in section 3 of the chapter.