Exchange And Bargaining Flashcards
Fallback position definition
What they experience in the absence of the exchange under consideration with its utility
(I,e worst utility they can get)
In an exchange game, what is the fallback position
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
Gains from trade formula
Utility gained from exchanging - utility from their fallback position (endowment)
2 aspects of exchange
Mutual benefits - i.e gains from trade for both agents
Conflict of interest - conflict over split of gains (both want large share)
Key aspects of rules of an exchange game (2)
Rule of law - allows each player the option to refuse offers, theft not allowed etc.
Private ownership - property rights are defined.
What do these key aspects (Rule of law and private ownership) (property) allow for?
Allows each player the option to refuse offers, so allowing exchanges to be pareto improvements over the endowment.
Voluntary exchange
Each player has the right to exclude the other from their bundle. Can’t be forced to trade.
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?
Participation constraints
Draw Pareto improving lens
Rules of a symmetric trading game
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)
S
V
V
V
In asymmetric exchange what do we have
Bargaining power
Example of bargaining power
Take it or leave it. (TIOLI power)
They set price and amount of good exchanged.
Example of TIOLI
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?)
TIOLI features
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.
Why is TIOLI PE
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)
3rd game: First mover advantage:
What is a benefit of first-mover
Price setting power
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?
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)
How does the first mover optimise her utility function
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.
Maths for A’s decision (finding B’s best response)
Pg 80
Just remember
Price = amount of data B gives up/amount coffee B gets
gugu
