Exchange And Bargaining

Question 1

Fallback position definition

Answer 1

What they experience in the absence of the exchange under consideration with its utility

(I,e worst utility they can get)

Question 2

In an exchange game, what is the fallback position

Answer 2

The endowment allocation. (The lowest utility they can get when exchange does not occur)

So if we exchange we must be better of i.e we get gains from tradd

Question 3

Gains from trade formula

Answer 3

Utility gained from exchanging - utility from their fallback position (endowment)

Question 4

2 aspects of exchange

Answer 4

Mutual benefits - i.e gains from trade for both agents

Conflict of interest - conflict over split of gains (both want large share)

Question 5

Key aspects of rules of an exchange game (2)

Answer 5

Rule of law - allows each player the option to refuse offers, theft not allowed etc.

Private ownership - property rights are defined.

Question 6

What do these key aspects (Rule of law and private ownership) (property) allow for?

Answer 6

Allows each player the option to refuse offers, so allowing exchanges to be pareto improvements over the endowment.

Question 7

Voluntary exchange

Answer 7

Each player has the right to exclude the other from their bundle. Can’t be forced to trade.

Question 8

So they will not exchange if it makes them worse off than their initial endowment.

What are the IC’s that include the endowment bundle called?

Answer 8

Participation constraints

Question 9

Draw Pareto improving lens

Question 10

Rules of a symmetric trading game

Answer 10

Start at endowment point Z (MRSs are different)

Pick a barter price midway between the MRS’s.
(Calculated by MRSa+MRSb/2)

Find amounts each wants at that barter price

Since voluntary, transfer the amount desired by the person who wishes to transact least. (E.g if i only want to trade a few pastries, then we are constrained by my desires)

Question 11

S

Question 12

V

Question 13

V

Question 14

V

Question 15

In asymmetric exchange what do we have

Answer 15

Bargaining power

Question 16

Example of bargaining power

Answer 16

Take it or leave it. (TIOLI power)

They set price and amount of good exchanged.

Question 17

Example of TIOLI

Answer 17

Ayanda will offer Biko an allocation where she has maximized her utility and Biko is better off than at his endowment. (She has to do that otherwise Biko won’t engage)

Her offer must satisfy Biko’s participation constraint (otherwise he’ll “leave it”). (Participation constraint is the IC that includes the endowment bundle called?)

Question 18

TIOLI features

Answer 18

Inequality: at participation-constrained outcomes, the bargainer with TIOLI power gets all of the economic rent;

Pareto efficiency: the participation-constrained outcome is Pareto-efficient.

Question 19

Why is TIOLI PE

Answer 19

Because if A is doing the best she can subject to B having some given level of utility (his participation constraint) the result must be PE, by the definition of PE.

I.e he can just walk away (so she can’t be better off without making B worse off, and will leave the deal)

Question 20

3rd game: First mover advantage:

What is a benefit of first-mover

Answer 20

Price setting power

Question 21

Example of first mover advantage

A is first mover and has price setting power. But not control over quantity that will be transacted at that price.

What must A’s offer satisfy?

Answer 21

Satisfies the incentive compatibility constraint (ICC)

First mover must provide incentives that B will take.

I.e B’s best response to act in ways that first mover prefers. (Second mover’s best response function)

Question 22

How does the first mover optimise her utility function

Answer 22

Backwards induction.

Choose strategy by anticipating strategies of other player in response to her choice. (I.e finding the 2nd movers best response function)

Then find the best offer that maximises value for her.

Question 23

Maths for A’s decision (finding B’s best response)
Pg 80

Answer 23

Just remember

Price = amount of data B gives up/amount coffee B gets

Question 24

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