EUROPEAN

f&i%F”IC
ELSEVIER European Economic Review 39 (1995) 1747-1764

Bargaining versus posted-price selling

Ruqu Wang
Economics Department, Queen’s University, Kingston, Ontario, Canada, K7L 3N6

Received April 1994; final version received January 1995

Abstract

Two popular selling methods - bargaining and posted-price selling - are compared here
in a dynamic model. When bargaining costs no more than posted-price selling, we find that
bargaining is always optimal. When bargaining costs more, however, bargaining is still
preferred if and only if the common cost for both selling methods is large enough. We also
find that an increase in the discount rate or the seller’s bargaining power favors bargaining.
Finally, we find that if the distribution becomes more dispersed and the increase in a
buyer’s valuation is sufficiently large, bargaining is more likely to be adopted.

JEL classification: C78; D42; D82

Keywords: Bargaining; Posted-price selling; Monopoly pricing

1. Introduction

An object can be sold in many different ways. Among them, three major selling
methods, bargaining, posted-price selling, and auctions, have now become part of
our everyday life. The co-existence of these different methods suggests that no
single method is optimal for all circumstances. New and used cars, for example,
are typically sold through bargaining. But these days hassle-free pricing seems to
emerge. Houses, as another example, are sometimes sold by bargaining, some-
times by posted prices, and sometimes even by auctioning.
There are two trends in the theoretical approaches to the optimal selection of
selling mechanisms (i.e., the selection of a mechanism that maximizes the seller’s
profit). The first approach is to use the Revelation Principle and compare all
incentive-compatible and individually rational mechanisms. Under suitable as-

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1748 R. Wang/European Economic Reoiew 39 (1995) 1747-1764

sumptions, a direct optimal mechanism can be found. ’ At the same time, other
researchers take into account the different cost structures in different selling
mechanisms, and compare two mechanisms at a time. Conditions are then derived
under which one selling mechanism is better than the other. Even though not all
feasible selling mechanisms are compared, this approach does yield many intuitive
conclusions on the co-existence and the relative advantages of different mecha-
nisms. 2
Experiments have also been conducted to compare different selling methods.
Hong and Plott (1982), for example, studied bargaining and posted-price selling in
a laboratory experiment. Recently, Bester (1993) considered the theoretical aspects
of the endogenous selection between bargaining and posted-price selling using a
model of competition between sellers who can control their product quality. He
found that bargaining can be an equilibrium when the discount factor is large
enough or when the seller’s bargaining power is small enough. Important ques-
tions arise when product quality is not an issue. Car dealers, for example, do not
produce cars themselves, and therefore moral hazard is not usually a concern.
Similarly, home-owners do not have a choice in quality at the time of selling their
houses. Obviously, further investigation is needed to explore the issue of whether
bargaining or posted-price selling should be chosen by a particular seller.
In this paper, we intend to address the above issue; that is, we intend to identify
the relative advantages of bargaining versus posted-price selling in the absence of
moral hazard. To simplify the analysis, we assume that a seller has a single object
for sale. Potential buyers arrive randomly according to some stochastic process
and the seller has a choice of selling it either by bargaining with the potential
buyers or by posting a fixed price. If the seller chooses to bargain, he is able to
discriminate (imperfectly) among buyers with different willingnesses-to-pay. How-
ever, additional employees must be hired to mingle with potential buyers. On the
other hand, posting a fixed, non-negotiable price is simpler and cheaper. But
discrimination is then impossible. Therefore, the seller faces a trade-off: bargain-
ing generates more revenues, but it costs more. Thus, the fundamental question of
this paper is: When will the seller choose to bargain with customers and when will
he choose simply to post a fixed price?
We find that the relative costs of bargaining and posted-price selling can
sometimes explain the adoption of each method. Important questions arise when
the use of a particular method cannot be explained by the operating costs involved.
Expensive goods are frequently sold by bargaining. Nevertheless, they are some-
times sold by posted price as well. Diamond rings are one such example. Hi-tech

1 Myerson (19811, Harris and Raviv (19811, Riley and Zeckhauser (1983), M&fee and McMillan
(1988), and Ehrman and Peters (19941, for example, belong to this group.
’ De vany (1987), Arnold and Lippman (19911, Bester (19931, Wang (1993), and this paper, for
example, belong to this group.
 R. Wang/European Economic Reciew 39 (1995) 1747-l 764 1749

electronic devices are another. Other factors affecting the choice of selling
mechanisms must be investigated.
Our analysis reveals that when the extra cost for bargaining (the bargaining
cost) is small, bargaining is obviously better than posted-price selling. When the
bargaining cost is not as small, but the common cost in bargaining and posted-price
selling (the displaying cost) is high enough, we find that bargaining is still the
preferred method. This is probably the main reason goods sold through bargaining
are usually large and very costly to display. We find further that a more dispersed
distribution of the buyer’s valuation has two effects on the seller’s profit in
bargaining. On the one hand, it directly increases his profit. On the other hand, it
tends to reduce the probability of selling (upon the arrival of a buyer) and thus
reduce the advantage of bargaining. This is not a problem in the comparison if the
buyer’s valuation for the more dispersed distribution is uniformly higher by some
margin, since a higher valuation distribution implies a higher probability of selling
upon a buyer’s arrival. This paper suggests that objects which are difficult to value
(SO that the distribution of buyers’ valuations is dispersed), and which are
expensive and costly to display, are more likely to be sold by bargaining.
We perform some comparative statics analyses in the paper. Similar to Bester
(19931, we find that a larger discount factor increases the relative profitability of
bargaining over posted-price selling. In contrast to Bester (19931, however, we
find that an increase in the seller’s bargaining power favors bargaining, which is
due to the non-competitiveness of the seller. Nevertheless, it is consistent with
Milgrom’s (1987) finding that a weak bargainer can benefit from selling methods
other than bargaining, such as auctioning (and in our case, posted-price selling).
The rest of this paper is organized as follows. In Section 2, we describe the
model, derive the optimal solutions for posted-price selling and bargaining, and
compare the profits generated by them. Section 3 contains some further remarks.
Lengthy proofs are relegated to an appendix.

2. The model

Suppose that a seller has an indivisible object to sell to some potential buyers.
These buyers arrive according to a Poisson process with rate of arrival A. Let V
be the valuation for the object (or the willingness-to-pay) of a buyer. For each
buyer, V is an independent private draw from a distribution characterized by c.d.f.
F( . > with continuous p.d.f. f( .) and support [ g, 111.The seller is assumed to be
risk neutral. The discount rate is given by S.
The seller can sell the object by either bargaining or posted-price selling. The
choice of selling method will surely affect the surplus of a buyer. Hence, it should
affect a buyer’s decision of where to shop when there are many sellers competing
with each other. Since in our model we have one seller, we assume that the choice
of selling method does not affect the buyers’ arrival rate.
1750 R. Wang/European Economic Review 39 (1995) 1747-I 764

Let us first consider posted-price selling. Let 8 be the rate of the cost of
displaying the object. Given that the seller always posts a price p, a potential
buyer with a valuation greater than or equal to p will buy the good right away.
The expected profit for the seller is then given by

IIP(p)=~m((p[~-~(p)] +IIP(p)~(p))e-“- ‘~Ps’H) dS(t),

where s(t) = 1 - e-*’ is the probability that the first buyer arrives by time t, and
[(l - e- “)/S]0 is th e accumulated discounted cost of displaying by time t.
Rewriting IIP( p), we have

nP(P>={P[l-F(P)l +wPv4P&+ /i+S’

Solving for IIP(p) from above, we have

APL1- F( P)l - @9
fl’( P) = h[l-F(p)] +a .
(1)
The seller maximizes his expected profit by maximizing the above HP(p) and
the optimal price p = p * satisfies the following first-order condition:

dnP( p)
0. (2)
dp =

Let J(p) =p - [Cl - F(p))/f(p)l. A ssume that J(. ) is a strictly increasing

function. 3 Given this monotonicity assumption, (2) uniquely characterizes the
optimal price p * . This is because from Cl),

dflP( p) Af( PI
[J(P) - UPCP>l.
dp =- Ail - F( p)l + 6
From above, it is easy to see that dIIP(0)/dp > 0, because nP(O> < 0 and
J(0) < 0. Furthermore, at dIIP(p)/dp = 0, J(p) - IIP(p) = 0, and

d2nP(p) d Af( P>

dp2 = --
dp i #-F(p)1 +a

-
Ai1
-F(
Af( PI
~11 + 6

3 This J( .) function is very commonly seen in auction literature. As developed in Bulow and
Roberts (1989), this function is actually the marginal revenue of a monopoly seller facing a buyer with
random willingness-to-pay. The assumption of monotonicity of this function also appears in Myerson
(19811, McAfee and McMillan (19881, Ehrman and Peters (19941, and Wang (1993), among many
others. Most commonly studied continuous distributions such as uniform, exponential, and normal
distributions, satisfy this property.
 R. Wang/European Economic Review 39 (1995) 1747-I 764 1751

From these two properties of Llp( p), we can conclude that there is a unique,
positive p * maximizing (1). Supposing that the seller always maintains this
optimal price p * , a buyer with a valuation higher than p * has no reason not to
buy the good right away, since the price will not be lower in the future. If a
potential buyer buys if his valuation is higher than the posted price, p * maximizes
the seller’s profit. Therefore, p * would certainly be the equilibrium price in this
seller-buyers’ game.
We shall next consider the seller’s profit generated from bargaining with
buyers. There are many ways to model the bargaining process between an arriving
buyer (with random willingness-to-pay) and the seller. 4 Obviously, different
bargaining processes definitely affect the bargaining outcome. Since the bargain-
ing process itself is not the focus of this paper, we shall keep it as simple as
possible in order to make our model tractable. We assume that in order to bargain
with buyers, the seller must increase his labor force by, for example, hiring a
salesperson who costs the seller an additional 0B (cost of bargaining). ’ We
further assume that the seller can set a reserve price r before buyers arrive ‘.
When a buyer arrives, the buyer’s valuation L‘and the seller’s reserve price r are
explicitly revealed to each other. 7 Given the respective bargaining powers of the
seller and the buyer, we assume that the generalized Nash Bargaining Solution is
the outcome of the bargaining. Therefore, given 1’2 r, the resulting bargaining
price is given by the solution to the following maximization problem:

max (u-d)‘p”(d-r)e.
Lit[r.t,]

where 1 - (Y and (Y, cxE [O,l], are respectively the bargaining powers of a buyer
and the seller. It is easy to see that the agreement price d = a I'+ (1 - (Y)r.
The assumption of a reserve price is motivated by both the auction literature
and the negotiation in a car dealership. In an auction, the seller of an object can set
a reserve price, the optimal value of which is higher than the seller’s real

‘See Admati and Perry (1987), Cramton (1992) and the references therein. Usually, multiple
equilibria exist and the revenue generated is very complicated to compute.
’ With this formulation, we implicitly assume that bargaining always costs at least as much as
posted-price selling. Situations occasionally occur where this is not true. But as we can easily see from
Lemma 1, whenever bargaining costs less than posted-price selling, bargaining generates more profit.
Therefore, while fIrc can be negative, whenever this happens the comparison is trivial. Hence, we shall
focus on the case that 0, is non-negative. 8, on the other hand, is always non-negative and is used to
capture that part of the costs common to both selling methods. For simplicity. we assume that H, is
fixed. The seller cannot increase OH to increase his bargaining power.
’ Imagine that the seller sets the reserve price but the negotiation takes place between the
salesperson and the buyer. See the next paragraph for further discussion.
’ In a bargaining model resulting in delayed agreement, I and r are eventually revealed. although it
usually takes time. Here, we assume that it takes no time. It may not be a realistic assumption, but it
simplifies the analysis greatly.
1752 R. Wang/European Economic Review 39 (1995) 1747-I 764

reservation value of the object. ’ This also happens when we buy a new car. The
owner of the dealership can set a reserve price before any negotiation begins. A
final price will be accepted by the owner if and only if it is greater than that
reserve price, and a portion of the profit from bargaining (d - r) will be awarded
to the salesperson. This situation is similar to the case of a firm where profit
maximization is usually assumed even though price decisions are not made by the
shareholders of the firm. As we shall see in Lemma 2, this reserve price is also
greater than the seller’s reservation value. The reserve-price assumption will be
crucial for Lemma 1. The major results of this paper, Theorem 1 and Corollaries 1
and 2, will remain valid, as long as the lowest possible final price in the
bargaining is always lower than the optimal posted price when the profits
generated from the two selling methods are equal. The real advantage of this
assumption is in the derivation of Theorem 2, which we conjecture would be
qualitatively unchanged if we adopt another bargaining process. See Section 3 for
further discussion.
Because there is additional cost involved, the rate of the operating cost is now
increased to 8 + OB. Here, 8 can be regarded as the normal displaying costs, and
0, as the cost of hiring additional employees to bargain with potential buyers,
which will not be incurred if a fixed price is posted. We assume that no cost is
incurred by the buyers. The expected profit of the seller is then given by

nB(r)=lb;([E(dlu>r)[l-F(r)] +IIB~(r)] e-6r

_ l-e-”
6 (0+%3) dS(t)
I

=[E(dIu>r)[l-F(r)] +I7’I+)]-&~.

For the optimal r, IIB(r) = IIB.

Similarly to (l), we can rewrite the above expression as follows:

JJB(r)= [UE(uloBr)thj:~~~~~;[:SF(r)l-e-e~. (3)

r

Given 8 and 8,, let p * be the optimal posted price and r * be the optimal
reserve price. We have the following lemma:

Lemma 1. If 0, = 0, then
II’ <IIB(r*);

’ See Milgrom and Weber (1982), for example, for various results in auction theory.
 R. Wang /European Economic Reciew 39 (1995) 1747-I 764 1753

that is, the profit generated from bargaining is at least as large as the profit
generated from posted-price selling if there is no extra cost for bargaining.

Proof. Recall that E( (Yu + (1 - a)r 1 L’ > r) > r, Vr. If O8 = 0, then

IIP(p*)<17B(p*)<maxZ7B(r)=17B(r*). 0
*
Lemma 1 implies that posted-price selling is used primarily because it has
lower operating costs. Bargaining with buyers would generate more revenue, but it
is time consuming and the costs involved are usually higher than merely posting a
fixed price. This lemma can also explain the use of bargaining in selling
hand-made souvenirs in tourist areas, since a person’s attendance is required
whether bargaining or posted price is actually used and there is little extra cost for
bargaining.
In the rest of this paper, we shall consider the case when 0B > 0. Let N(r) and
D(r) denote respectively the numerator and denominator of (3). The first-order
condition determining the optimal r is
dIIB( r)
=-_N’(r) N(r)
dr D(r) [D(r)]2D’(r) =”

As in the case of posted-price selling, given the monotonicity assumption of J(. )

the second-order condition is always satisfied for any r characterized by Eq. (4)
above.
It is easy to see that D’(r) = - hf( r). Because
F
L$( Ll)dv
/
E(ulr>r) = r
l-F(r) ’
we can rewrite N(r) as

N(r)=h[o/iuf(i;)dc+(l-a)r(l-F(r))]-B-R,.
r
Hence,
N’(r)=A[-czrf(r)-(l-a)rf(r)+(l-a)(l-F(r))],
and (4) becomes

(5)
Note that the above expression holds only for the optimal r.
We have the following Lemma:

Lemma 2.
r* >lI”(r*), Vc~<l.
1754 R. Wang/European Economic Review 39 (1995) 1747-l 764

Prooj From (51,

1 -F(r*)
P(r*)=r* -(l-(Y) f(r*) <r*. q

Lemma 2 implies that a seller who bargains will set a reserve price (r * ) that is
higher than he can earn (LZ B( r * )) in future sales, as in the case of the optimal
reserve price in an auction. Therefore, the seller in our model may refuse an offer
that is strictly higher than what he expects to get by waiting. This may explain
why, occasionally, a deal between a salesperson (of new cars, etc.) and a buyer
may be rejected by higher-level management.
Whether the seller can credibly set the reserve price higher than the amount he
can earn from future sales also arises in posted-price selling. By letting (Y= 0 in
the proof of Lemma 2, the optimal posted price is also higher than the seller will
get in the future. We believe that the level of commitment ability is essentially the
same in both selling methods. If one can commit to a fixed posted price, one can
also commit to a firm reserve price. If one cannot commit to a reserve price, one is
probably not able to commit to a posted price either, and the analysis in this paper
becomes inappropriate. 9
It is easy to see that the optimal posted price p* will sometimes be lower or
higher than the optimal reserve price r * , depending on the shape of the distribu-
tion function F( .) and the various operating costs. Moreover, the revenues
generated from these two different selling mechanisms are not always equal. The
following lemma, however, states that whenever the optimal profits generated
from the two selling mechanisms are the same, the optimal posted price is always
higher than the optimal reserve price in bargaining, which in turn implies that the
probability of a successful sale (upon the arrival of a buyer) is higher for
bargaining. Even though this property holds only when the two profits are the
same, it is essential to the analysis in the rest of this paper. Its logic is simple:
when two profit functions are compared, the point at which they are exactly equal
is most important. If the two profits are very different, a small change in the
parameters will not affect the choice of the seller. If the two profits are very close,
however, the following lemma provides a way to diagnose the relative damage to
the two profits by a small increase in 0.

Lemma 3. zfnP(p*)=nB(r*),‘thenp* >r*

Proof From (51, we have

IfB(r*)=cyr* +(l-cx)J(r*). (6)

9 See Peters (1993) for an analysis of such a situation

 R. Wang/European Economic Review 39 (1995) 1747-I 764 17.55

By letting (Y= 0 and 0B = 0 in (3) and (5), we have a similar formula for the
optimal posted price:

P( p*) =J( p*). (7)

Since r* >J(r*), IZB(r*)=UP(p*> ’ pl ies that J( p * > > J( r * ). By assump-
im
tion, J( 21) is strictly increasing. Therefore, p * > r * . 0

This lemma implies that whenever the profits generated by bargaining and
posted-price selling are equal, the probability of selling (in any finite period of
time) is higher in bargaining. This is because the reserve price in bargaining is
lower than the posted price. (Of course, the object will be sold eventually by either
method.) Imagine the case where (Y= 1. The seller has all the bargaining power
and the final price is equal to the buyer’s willingness-to-pay. In this case, the seller
would set a reserve price that is exactly equal to what he can get from future sales
( flB(r * 1). As we discussed after Lemma 2, the optimal posted price is higher
than the amount the seller can get from future posted-price selling. Therefore,
when the future profits are the same, the posted price must be higher than the
reserve price. This continues to be true when 0 < (Y< 1.
We shall now examine the relative advantage of posted price versus bargaining
given different levels of common operating costs 8. For any given 8, let
p * = p * (0) be the optimal posted price and r * = r * (0) be the optimal reserve
price. We have the following theorem:

Theorem 1. Thereexistsa unique 6, such that II”(r ‘(0)) > nP(p*(0)) ifand
only if 0 2 6, where 0 < 6 < m at least for some ualues of 8,.

Proof (i) If IIP(p*(B))~HB(r*(0)), WE[O,~), then e^= +m.

(ii) If nP(p*(8))~n”(r*(e)>veE[0,~), then 6=0.
(iii) Suppose that nP( p * (6)) = ZIB( r * (6)), for some e^E (O,m). Making use of
the Envelope Theorem, we have

dflP(P*F)) anP(P*W) = _ 1
(8)
d0 = al3 h[l-F(p*(@)] +a’

dZIB(r*(0)) alIB(r*(0)) 1
(9)
d0 = a0 = - A[1 -F(r*(e))] +S’

Since at 0= 6, nP(p*(6))=17”(r*(e^>), from Lemma 3, p*(i)>r*(i).

Hence, from (8) and (9), we have

dnP(p*(o)) < dn’(r*(@))

(10)
d0 d0
1756 R. Wang/European Economic Review 39 (1995) 1747-l 764

at 0= 6. That is, at euery intersection of n= nP(p*(0)) and n= nB(r*(0)),

the first curve is strictly steeper (negatively) than the latter. Therefore, there can be
only one such intersection. Hence, I7a(r * (0)) > 17’ ( p * (0)) Vt9> 6, and
nB(r*(8))<nP(p*(0)) vo< 6.
We shall prove that Case (iii) does occur for some 0,. In fact, we can prove
that for any value of 8, we can find a 8, > 0, such that for this 0,, UB(r * (0)) =
If’(p * (8)). This can be done by increasing 0, from 0 to + 00. At 0, = 0,
UB > Up (from Lemma 1). As 19, increases, the profit from bargaining de-
creases (to zero). Therefore, there must exist a unique 8,, such that the profits
generated from these two methods are the same. 0

The intuition of this theorem can be expressed in terms of 0,. lo In Case (i), 0,
is probably very large, and bargaining generates less profit regardless of the value
of 8. In Case (ii), 0, is probably very small, and from Lemma 1 bargaining
always dominates posted-price selling. Case (iii) occurs when 0, is intermediate.
For some 8, bargaining i: better than posted-price, and vice versa for some other
8. Suppose that at 8 = 8, the profits generated by the two selling methods are
equal. From Lemma 3, the probability of a sale upon an arrival is higher for
bargaining. Therefore, a marginal increase in 8 will give bargaining a slight
advantage, since it sells faster than posted-price selling.
TheArelationship between Ba and 6 can be investigated further. We can prove
that do/de, > 0 along 17’ = n ‘. This is because a( I7’ - 17 P)/aO > 0 from the
proof of Theorem 1 and a( UB - n’>/M, = aUB/M, < 0. Fig. 1 summarizes
these findings. Note that Case (i) may or may not occur depending on whether or
not UB = 17’ converges to some finite value as 6 goes to infinity.
The same method can also be applied to discount rate 6. This is because it
takes the seller longer to sell the good by posted price and a larger discount for
future profits favors whichever selling method that sells faster. We have the
following corollary:

Corollary 1.

that is, an increase in S favors bargaining.

Proof: See Appendix.

Due to the competition between sellers, Bester (1993) concludes that an

increase in the seller’s bargaining power would jeopardize the bargaining equilib-

lo I would like to thank a referee for his/her insight on this.

 R. Wang/European Economic Review 39 (1995) 1747-I 764 1757

Case i)

Case iii)

case ii)

Fig. 1. The relationship between 0, and 4.

rium. It should not be the case here because the seller is a monopolist in our
model. We have the following corollary:

Corollary 2.

dWr*(W >o.
>
da
that is, an increase in the seller’s bargaining power increases the seller’s profit
from bargaining and thus favors bargaining.

Prooj Applying the Envelope Theorem to (3), we have

dIIB(r*(0)) an”(r*(O)) [E(tjIu>r*)-r*]l[l-F(r*)]

=
da = aa A[1 -F(r*)] + 6 .

SinceE(uIv>,r*)>r’,d~B(r*(~))/da>O. 0

One important question about the
distribution of the buyer’s valuation
Wang (1993), we find that it is easier
which is always equal to [O, 11. Let u
c.d.f. of random variable Vi, i = 1,2.
optimal selection of mechanisms is how the
affects the selection outcome. Similarly to
to compare two distributions on their range,
= G,(6) = F,-‘(4) denote the inverse of the
We have the following lemma:

Lemma 4. (i) G’,( c$) > G;( +)V C#J

E [O,l] * Var(V,> > Var(V,).
(ii) G,(4) > G,(4) V 4 E [O,ll = F,(u) < F,(u) Vu.
1758 R. Wang/European Economic Review 39 (1995) 1747-I 764

Prooj (i) See Wang (1993).

(ii) Let $J = F,(u). G,(4) > G,(4) im pl ies that v > G,(F,(v)). Since G, is the
inverse of F2, we have F,(U) > F,(u). 0

Lemma 4 implies that a uniformly steeper G(4) curve represents a more

dispersed distribution. That is, F,(u) has a larger variance and wider support than
F,(u). Furthermore, F,(v) is flatter than F,(u) at every 4 E [O, l] (or equivalently,
at every pair of v1 and v2 that F,(v,) = F,(u,)). A uniformly higher G(4) curve,
on the other hand, indicates a first-order stochastic domination. Note that the
comparison in (i) or (ii) is partial. It is very likely that two distributions do not
have this kind of uniform relationship. Relative to other dispersion notions, such
as those in Rothschild and Stiglitz (1970), the comparison here is more narrowly
and specifically defined. A similar comparison was also adopted in Wang (1993).
To capture the effects of buyers’ valuation on the choice of a selling mecha-
nism, we rewrite the seller’s profit from bargaining. (Notice that the profit from
posted-price selling can also be expressed in the following formula by letting
(Y= 0 and 0, = 0.) Recall that

l+Iu>+ ‘;y:qi. = ‘;iy;;‘:.

r r

Let u = F-‘(p) = G(q). Then 40= F(u) E [O, 11. If we change the variable
from v to CP,and change the limits of the integral in the above equation from E to
1 and from r to 4 = F(r ), we have /,” vd F( v) = /i G( cp)d cp. Therefore, from (3),
we have

/ ‘G(V) dp
a+ + (1- cy)G(+) A(1 - 4) - 8- 13,
l-4
I I
fl”@) = . (11)
A(l-4)+6

Assuming that d2nB(+)/d 4’ < 0 V4 E [0,11, the optimal 4 * is given by

dII”(+*)/d4=0.
Let G(+, /J) = pG,(4) + (1 - p)GZ(4), p E [O, 11, be the average of the two
inverse c.d.f.‘s. Obviously, G($, 1) = G,(4), CC+, 0) = GJ+), and G,( 4, ~1 =
G,(4) - G,(4). The following lemma outlines the effect of p on the optimal #J * ,
the probability of a no-sale upon the arrival of a buyer:

Lemma 5. IfQ4 E [O,

11,

G,(4) -G,(4) 2 (I+f )(l-4+;(4) -G;(4)] 2% (12)

 R. Wang/ European Economic Review 39 (1995) 1747-l 764 1759

then

Proof See Appendix.

The condition in this lemma guarantees that 4 * is higher when p = 0. That is,
the probability of a no-sale upon an arrival is higher for distribution F2, which is
first-order stochastically dominated by F,. This is quite intuitive, because when
the buyers’ valuations are higher, the revenue from a sale is higher, and the seller
has more incentive to sell the object faster.
We shall investigate the effects of the buyers’ valuation on the choice of selling
mechanisms given that all other aspects regarding the two selling mechanisms are
unchanged. To do this, we shall vary LYand 6,. Obviously, a larger (Y‘or a lower
f3, would favor bargaining. By keeping IIB constant, from (11) the slope of the
iso-profit curve is given by

(13)

As noted earlier, at (Y= 0, = 0, the optimal profit from bargaining is identical to

the optimal profit from posted-price selling. Therefore, the iso-profit curve

P(+*, /.L; a, e,) =n”#J*, /4&O) =~n’(&“,/-+

separates the bargaining preferred region from the posted-price preferred region.
Let 48, 17,’ be the respective profits for distribution F,(.), i = 1,2. By
investigating the effect of /1 on the slope of the iso-profit curve, we are able to
make a comparison on the relative profits between two distributions. We have the
following theorem:

Theorem 2. Suppose that VC$ E 10,11,

6) G’,(4) > G’,(4);
(ii) G,(4) - G,(4) > (1 + h/6X1 - +)[G’J+) - G’J4)l.
Then

that is, bargaining is preferred on more occasions for F,( . ) than for Fz(. 1.

Proof: See Appendix.

Condition 6) states that distribution F, is more dispersed than F2. Condition

(ii) requires that the valuations of the buyers from distribution F, should also be
1760 R. Wang/European Economic Review 39 (199.5) 1747-I 764

significantly higher (in the sense of first-order stochastic domination) than those
from F2; how much higher is related to the dispersion condition and is given by
Lemma 5.
If one of the conditions in Theorem 2 is a strict inequality, the conclusion is
also a strict inequality. A more dispersed buyer valuation has two effects on the
seller’s profit from bargaining. The direct effect is to increase the revenue of the
seller, as captured by the first term in (16). Given the same level of 4, the seller is
able to retain more surplus from a more dispersed distribution. The indirect effect,
however, works in the opposite direction. For a more dispersed distribution, the
seller tends to set a higher level of 4, reducing the probability of a sale upon an
arrival and thus the advantage of bargaining. One way to decrease the optimal
level of 4 is to increase the valuation of the buyers, as stated in condition (ii). It is
easy to see that the sufficient conditions provided by Theorem 2 are not necessary.
However, less restrictive conditions have not been obtained.
As a special case in Theorem 2, when the buyer’s valuation shifts up equally,
bargaining becomes more desirable. This corollary provides a justification for the
intuition that more expensive goods are more likely to be sold by bargaining. l1
The proof is obvious.

Corollary 3. I. V+ E [O, 11, G,(4) - G,(4) = V> 0, then

3. Concluding remarks

In the previous sections, we considered two popular selling methods - bargain-

ing and posted-price selling - in an asymmetric information model. Since posted-
price selling will never be adopted when the operating costs associated with the
two selling methods are identical, we concluded that cost saving consideration is
probably the main reason for the popularity of posted price. If the seller has many
objects to sell and there are many potential buyers, for example, posted-price
selling is expected. We found that when bargaining costs more, an increase in the
common operating costs 0 favors bargaining. This is because when the two profits
are equal, bargaining has a higher probability of selling upon an arrival. In the
model, we also analyzed how a more dispersed distribution of the buyer’s

rr The following fact may he regarded as a confirmation of this corollary. As the economy has
worsened and people’s willingness-to-pay has decreased, some car manufacturers have begun offering
hassle-free car models such as Saturns, Escorts, Thunderbirds, and a number of other models. These
cars are being sold with a ‘no-dicker’ sticker. Buyers get a pre-determined package of ‘options’ at a
fixed price.
 R. Wang/ European Economic Review 39 (1995) 1747-l 764 1761

valuation affects the seller’s choice of selling mechanisms. We found that the
effect is two-fold. As a special case, when the buyer’s valuation increases
uniformly and equally, bargaining becomes a more desirable way to sell the
object.
We considered only a single object in this paper. The analysis can be applied to
the case of finitely many objects. The analysis does not apply to the case where
identical objects can (and will) always be replaced at some costs. In this case, the
common displaying cost 0 is incurred by the seller regardless of which method the
seller has chosen and whether the object is being sold successfully. Therefore, it
should not affect the comparison between bargaining and posted-price selling.
We selected a very simple bargaining solution in the model. Other types of
solutions should fit nicely into it, given that the lowest possible acceptable price
from the negotiation is lower than the optimal posted price when the profits
generated are equal. As long as the surplus is split according to the bargaining
powers of the seller and the potential buyers, the major qualitative results in our
paper should remain valid.
The identical and independent distribution assumption of buyers’ valuations
should bias the results towards posted-price selling. Apparently in many bargain-
ing models, more information is revealed in the bargaining process than a seller
can learn from a single fixed price. Therefore, when the buyers’ valuations are
closely related, bargaining seems to be an even better way to sell the good. This
conjecture, however, needs to be verified in a more general model.

Acknowledgment

I would like to thank Marilyn Banting, Michelle Eggleston, Preston M&fee,

Mike Peters, Bob Rosenthal, David Scoones, Jeroen Swinkels, Guofu Tan, Doug
Tattrie, Jean-Francois Wen, and especially the editor, Seppo Honkapohja, and two
anonymous referees for their very helpful comments. This research is supported by
the Social Sciences and Humanities Research Council of Canada.

Appendix: The proofs of Corollary 1, Lemma 5, and Theorem 2

Proof of Corolla?yI

From (1) and (3), we have

an’(P) np( PI
a6 = - A[l-F(p)] +6’
1762 R. Wang/Eur@ean Economic Review 39 (1995) 1747-I 764

and

aIIB( r) Wr)
a6 = - A[1 -F(r)] + 8’

At 8= 4, IIP(p*(6))=II”<r*<6)>, and p*(8^)>r*(& Therefore,

UI’(p*(e^)) UI”(r*(l)) <o

(A.1)
a6 - as

From (8) and (9),

UI’(p*(a)) aII”(r*(e^)) <O

-
ae (A.21
a0
Totally differentiating IIP( p * (6)) - 17’(p * (6)) = 0 with respect to 6 and
6, we have

a(np-nB) + a(nP-US) de^

- 0.
a6 ae ds-
Therefore, from (A.11 and (A.21 we can conclude that dB^/dS < 0.

Proof of Lemma 5

Let IIB(+, p) denote the seller’s profit from bargaining when the inverse
c.d.f. is G(& ~1. We have

anB(+*, 4 0 aznB(4*, P) <O

a+ =) a@ *

Differentiating the above first-order condition with respect to /L, we have

a2nB(cP*+) d+* + a2rrY+*+) 0

.-
a@ dl.L a+ap = .

We only need to prove that a21ZB( C$* , &/a@~ < 0. Since

we have
 R. Wang/ European Economic Reuiew 39 (1995) 1747-l 764 1763

A6
j--‘$(a.P>do
=- +(L-c+,(~~ I-4
[h(l-+)+a]’ l-4

where in the above equation we make use of the following:

/‘[ GJ cp, p) - G,( 4, CL)]dq = /‘Cl- cp)G,d9, FL)dq.

4 4

Eq. (12) implies both

W - 4)
6 - CP)G,&A P) do,

and
A(1 - 4)
6 (I- W/x+,(& CL).

Therefore, a211 ‘( C/J* , p)/tk#dp < 0 and hence d 4 * /d P < 0.

Proof of Theorem 2

From (13), we have

1764 R. Wang/European Economic Review 39 (1995) 1747-l 764

From condition (ii) and Lemma 5, we have d +/d/L < 0. Since G’,(4) > G;(C)),
(A.3) is positive. Therefore,

and we complete the proof of this theorem.

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