Costs of Implementation: Bargaining Costs versus Allocative Efficiency

Christian Zehnder, and workshop participants at MIT and Harvard are gratefully acknowledged. Of course, the usual disclaimer applies. 2 A mechanism with low direct cost of use may be preferred to alternatives implementing more efficient allocations. We show this experimentally by giving pairs of subjects the option to agree on a single average price for a sequence of trades – in effect pooling several small bargains into a larger one. We make pooling costly by tying it to some inefficient trades, but subjects nevertheless reveal strong tendencies to pool, particularly when more bargains remain to be struck and when bargaining is face to face. The results suggest that implementation costs could play a significant role in the use of many common trading practices, including the employment relationship. Abstract 3 The original literature on comparative economic systems evaluates mechanisms in terms of their ability to implement efficient allocations as well as the costs of required Yet, the latter class of costs plays almost no role in modern thinking on mechanism and market design. Challenging this practice, we provide experimental evidence, showing that players trade-off efficiency for costs by accepting less efficient allocations in exchange for fewer rounds of bargaining. In our studies, subjects have the option to agree on a single average price for a sequence of small trades – in effect pooling several bargains into one. The experiments impose no artificial bargaining costs; subjects' only gain from pooling is to reduce the amount of bargaining they have to do. In spite of this, many pairs of subjects agree to pool, even at the cost of completing some inefficient trades. The tendency to pool is stronger when the associated allocative inefficiencies are smaller, when more rounds of bargaining are " saved " , and when bargaining is face-to-face. On the other hand, the time saved by pooling does not appear to be a significant factor. Agreements on pooling prices are preceded by a larger number of offers and counter-offers than agreements on individual prices. Part of this is due to the fact that pairs who eventually choose to pool make more offers than pairs who never pool, even when negotiating individual prices. Beyond suggesting that bargaining costs are positive, a more specific implication of our results is that these costs are sub-additive (since subjects prefer to bargain over a single pooled price rather than over a sequence of individual prices). Sub-additivity …