Bargaining Power

Bargaining power is the relative ability of parties in an argumentative situation (such as bargaining, contract writing, or making an agreement) to exert influence over each other. If both parties are on an equal footing in a debate, then they will have equal bargaining power, such as in a perfectly competitive market, or between an evenly matched monopoly and monopsony.

There are a number of fields where the concept of bargaining power has proven crucial to coherent analysis, including game theory, labour economics, collective bargaining arrangements, diplomatic negotiations, settlement of litigation, the price of insurance, and any negotiation in general.

Calculation

Several formulations of bargaining power have been devised. A popular one from 1951 and due to American economist Neil W. Chamberlain is:

:We may define bargaining power (of A, let us say) as being the cost to B of ''disagreeing'' on A's terms relative to the costs of ''agreeing'' on A's terms ... Stated in another way, a (relatively) high cost to B of disagreement with A means that A's bargaining power is strong. A (relatively) high cost of agreement means that A's bargaining power is weak. Such statements in themselves, however, reveal nothing of the strength or weakness of A ''relative'' to B, since B might similarly possess a strong or weak bargaining power. But if the cost to B of disagreeing on A's terms are greater than the cost of agreeing on A's terms, while the cost to A of disagreeing on B's terms is less than the cost of agreeing on B's terms, then A's bargaining power is greater than that of B. More generally, only if the difference to B between the costs of disagreement and agreement on A's terms is proportionately greater than the difference to A between the costs of disagreement and agreement on B's terms can it be said that A's bargaining power is greater than that of B.

In another formulation, bargaining power is expressed as a ratio of a party's ability to influence the other participant, to the costs of not reaching an agreement to that party:

:$BP_A \text = \frac$

:$BP_B \text = \frac$

:If $BP_A$ is greater than $BP_B$, then A has greater Bargaining Power than B, and the resulting agreement will tend to favor A. The reverse is expected if B has greater bargaining power instead.

These formulations and more complex models with more precisely defined variables are used to predict the probability of observing a certain outcome from a range of outcomes based on the parties' characteristics and behavior before and after the negotiation.

Buying power

Buying power is a specific type of bargaining power relating to a purchaser and a supplier. For example, a retailer may be able to dictate price to a small supplier if it has a large market share and or can bulk buy.

Economic theory

In modern economic theory, the bargaining outcome between two parties is often modeled by the Nash Bargaining solution. An example is if party A and party B can collaborate in order to generate a surplus of $100$. If the parties fail to reach an agreement, party A gets a payoff $X$ and party B gets a payoff $Y$. If $X+Y<100$, reaching an agreement yields a larger total surplus. According to the generalized Nash bargaining solution, party A gets $X+\pi(100-X-Y)$ and party B gets $Y+(1-\pi)(100-X-Y)$, where $0 < \pi < 1$. There are different ways to derive $\pi$. For example, Rubinstein (1982) has shown that in a bargaining game with alternating offers, $\pi$ is close to $1$ when party A is much more patient than party B, while $\pi$ is equal to $\frac$ if both parties are equally patient. In this case, party A's payoff is increasing in $\pi$ as well as in $X$, and so both parameters reflect different aspects of party A's power. To clearly distinguish between the two parameters, some authors such as Schmitz refer to $\pi$ as party A's ''bargaining power'' and to $X$ as party A's ''bargaining position''. A prominent application is the property rights approach to the theory of the firm. In this application, $\pi$ is often exogenously fixed to $\frac$, while $X$ and $Y$ are determined by investments of the two parties.

See also

* Bargaining
* Collective buying power
* Inequality of bargaining power
* Intra-household bargaining
* Porter five forces analysis
* Purchasing power

References

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Bargaining theory
Cooperative games