Price Negotiation and Bargaining Costs∗

We study the role of consumers’ psychological bargaining costs associated with the decision to bargain in a retail setting. First, we use a simple model to show how a retailer’s optimal pricing strategy (fixed pricing vs. bargaining) varies with consumers’ bargaining costs and the retailer’s marginal costs. We then prove how these fixed bargaining costs can be nonparametrically identified separately from bargaining power and marginal utility of income. Using individual-level data on refrigerator transactions, we find that through bargaining, consumers keep on average 40% of the available surplus. We estimate an average bargaining cost of $28, i.e. on average consumers will negotiate prices if they get a discount of more than $28. While there exists substantial heterogeneity in bargaining costs, these costs are relatively low as compared to the retailer’s markup; thus, making a hybrid strategy (where retailers post prices but allow consumers to bargain) more profitable than fixed pricing. Finally, we provide evidence that ignoring bargaining costs may lead to biased counterfactual pricing analysis.