Social Preferences and the Efficiency of Bilateral Exchange

Without contracting or repetition, purely self-regarding agents will not trade. To what extent can social preferences, such as altruism or a concern for fairness, generate efficient bilateral exchange? I analyze a simple exchange game: A purely self-regarding first mover transfers some amount of a commodity to a second mover. Then the second mover, who has social preferences defined over material payoffs, transfers a commodity back to the first mover. I identify key properties of social preferences that matter for bilateral exchange behavior. I find the equilibrium will be efficient if either (1) the second mover’s transfer is monetary (i.e., material payoffs are quasi-linear in the second mover’s commodity), or (2) the second mover’s social preferences cause him to behave in accordance with a “fairness rule” (such as the 50-50 sharing norm). The results may explain why small-scale transactions with discretionary monetary payment are common, and suggest that social norms that prescribe fair allocations promote efficiency in exchange environments. JEL classification: D63, J33, J41, M52, D64