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Summary ECO2003 Bargaining notes
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ECO2003 Bargaining notes
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BARGAINING, INSTITUTIONS AND ALLOCATIONSWEEK ONE
Concepts
1. identify Pareto-efficient outcomes along with outcomes that are Pareto-
dominated by others.
2. differentiate between a substantive judgement of fairness and a procedural
judgment of fairness.
Basic farming model
1. graph and explain the shape of Angela's feasible frontier.
2. graph and explain Angela's indifference curves.
3. calculate the marginal rate of transformation given some functional form of
the feasible frontier.
4. calculate the marginal rate of substitution given some functional form of the
indifference curves.
5. explain, in detail, the stable equilibrium in the case where Angela is free to
farm the land as she sees fit.
Revision: Unit 3. Scarcity, Work and Choice, parts 3.1 to 3.5
Required: Unit 5. Introduction to part 5.4
Required: Leibnizes 3.2.1, 3.4.1 & 3.5.1
,UNIT 5: PROPERTY AND POWER
How institutions influence the balance of power in economic interactions,
and affect the fairness and efficiency of the allocations that result
• Technology, biology, economic institutions, and people’s preferences are all
important determinants of economic outcomes.
• Power is the ability to do and get the things we want in opposition to the intentions
of others.
• Interactions between economic actors can result in mutual gains, but also in
conflicts over how the gains are distributed.
• Institutions influence the power and other bargaining advantages of actors.
• The criteria of efficiency and fairness can help evaluate economic institutions and
the outcomes of economic interactions.
5.1 Institutions and power
Institutions: are written and unwritten rules that govern:
- What people do when they interact in a joint project
- The distribution of the products of their joint effort
The institutions provided both the constraints and the incentives
the rules of the game affect:
• how the game is played
• the size of the total payoff available to those participating
• how this total is divided
For example, in the ultimatum game the rules (institutions) specify the size of the pie, who
gets to be the Proposer, what the Proposer can do (offer any fraction of the pie), what the
Responder can do (accept or refuse), and who gets what as a result
,POWER
The ability to do and get the things we want in opposition to the intentions of others
Power in economics takes two main forms:
• It may set the terms of an exchange: By making a take-it-or-leave-it offer (as in the
ultimatum game).
• It may impose or threaten to impose heavy costs: Unless the other party acts in a
way that benefits the person with power.
The rules of the ultimatum game determine:
• the ability that the players have to obtain a high payoff
• the extent of their advantage when dividing the pie—which is a form of power
called bargaining power
The power to make a take-it-or-leave-it offer gives the Proposer more bargaining power
than the Responder, and usually results in the Proposer getting more than half of the pie.
Still, the Proposer’s bargaining power is limited because the Responder has the power to
refuse.
If there are two Responders, the power to refuse is weaker, so the Proposer’s bargaining
power is increased.
The power to say no
Suppose we allow a Proposer simply to divide up a pie in any way, without any role for the
Responder other than to take whatever he gets
- Under these rules, the Proposer has all the bargaining power and the Responder
none.
- There is an experimental game like this, and it is called: the dictator game.
, 5.2 Evaluating institutions and outcomes: The Pareto criterion
We want to be able to describe what happens and to evaluate it—is it better or worse than
other potential outcomes?
The first involves facts; the second involves values.
We call the outcome of an economic interaction an allocation.
In the ultimatum game, for example, the allocation describes the proposed division of the
pie by the Proposer, whether it was rejected or accepted, and the resulting payoffs to the
two players.
THE PARETO CRITERION
According to the Pareto criterion, allocation A dominates allocation B if at least one party
would be better off with A than B, and nobody would be worse off.
We say that A Pareto dominates B.
Now suppose that we want to compare two possible allocations, A and B, that may result
from an economic interaction.
• Can we say which is better?
Suppose we find that everyone involved in the interaction would prefer allocation A.
Then most people would agree that A is a better allocation than B.
This criterion for judging between A and B is called the Pareto criterion
Note that when we say an allocation makes someone ‘better off’ we mean that they prefer
it, which does not necessarily mean they get more money.
Figure 5.1 Pareto-efficient allocations. All of the allocations except mutual use of the
pesticide (T, T) are Pareto efficient.
Figure 5.1 compares the four allocations in the pest control game by the Pareto criterion
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