Bargaining Power
Bargaining power is the ability of a party in a negotiation to influence the terms of an agreement in its favour. In economics, bargaining power is central to the analysis of wage determination, of price negotiation, and of the division of surplus in relationships between firms, workers, and other parties.
Sources of Bargaining Power
Bargaining power depends on the alternatives available to each party and on the cost of failing to reach agreement. A party with attractive outside options can credibly threaten to walk away, strengthening its position. A party with poor alternatives is more dependent on the relationship and has less power.
Other sources include the control of information, the ability to commit, the patience of the parties, and the structure of the negotiation. Parties that can commit to a position, that are less impatient, or that control critical resources have greater bargaining power.
Models of Bargaining
The analysis of bargaining uses several models. The Nash bargaining solution provides a general framework, in which the outcome depends on the disagreement point, the payoffs if no agreement is reached, and on the relative bargaining power of the parties.
Sequential bargaining models, based on alternating offers, derive the outcome from the structure of the negotiation and from the patience of the parties. The Rubinstein model shows that the party that is more patient, or that has a lower discount rate, obtains a larger share of the surplus, because it can afford to wait longer for agreement.
Application to Labour Markets
In labour markets, bargaining power determines wages and employment. Workers with scarce skills, with strong unions, or with attractive alternative employment have greater power, and wages reflect this. Employers with monopsony power, or with abundant alternative labour, have greater power and can set lower wages.
The analysis of bargaining power informs the understanding of wage determination, of the effects of unions and minimum wages, and of the response of wages to changes in economic conditions. It also informs the analysis of the labour share of income and of the distribution of the gains from production.
Application to Firm Relationships
Bargaining power is central to the analysis of relationships between firms, including those in supply chains, joint ventures, and vertical relationships. The division of surplus between a supplier and a buyer depends on the alternatives available and on the specificity of the investment. Where one party has made a specific investment, it is vulnerable to hold-up and may receive a smaller share of the surplus.
The analysis informs the design of contracts and of governance arrangements, including vertical integration, and it clarifies the conditions under which relationships are sustained or terminated. It also informs the analysis of competition and of the effects of market structure on the distribution of surplus.
The Nash Bargaining Solution
The Nash bargaining solution provides a general framework for analysing bargaining outcomes. It predicts that the parties will agree on an outcome that maximises the product of their gains over the disagreement point, weighted by their bargaining power.
The solution depends on the disagreement point, the payoffs if no agreement is reached, and on the relative bargaining power of the parties. It provides a convenient way to model bargaining without specifying the details of the negotiation process.
Alternating Offers
The alternating-offers model analyses bargaining as a sequential process in which the parties take turns making offers. The Rubinstein model shows that, under certain conditions, the outcome is unique and depends on the patience of the parties.
The analysis clarifies the role of time preference and of the cost of delay in determining the division of the surplus. The party with the lower discount rate, or with the greater ability to wait, obtains a larger share, reflecting its greater patience.
Bargaining in the Labor Market
In the labour market, bargaining determines wages and employment. The analysis of bargaining power informs the understanding of the effects of unions, of minimum wages, and of other institutions on wages and employment.
The framework also informs the analysis of the labour share and of the distribution of the gains from production. Changes in bargaining power, driven by changes in institutions or in market conditions, affect the distribution of income between labour and capital.
Implications for Policy
The analysis of bargaining power has implications for policy. Policies that affect the alternatives available to the parties, including unemployment benefits and competition policy, affect bargaining power and the resulting outcomes.
The design of these policies must consider their effects on efficiency and on distribution. Bargaining power affects not only the division of surplus but also the incentives for investment and for participation, and the analysis of these effects informs the design of institutions and of policy.