Bargaining power is the relative power of parties in a situation to exert influence over each other. If both parties are on an equal footing in a debate, then they will have equal bargaining power, such as in a perfectly competitive market, or between an evenly matched monopoly and monopsony.
There are a number of fields where the concept of bargaining power has proven crucial to coherent analysis: game theory, labour economics, collective bargaining arrangements, diplomatic negotiations, settlement of litigation, the price of insurance, and any negotiation in general.
- We may define bargaining power (of A, let us say) as being the cost to B of disagreeing on A's terms relative to the costs of agreeing on A's terms ... Stated in another way, a (relatively) high cost to B of disagreement with A means that A's bargaining power is strong. A (relatively) high cost of agreement means that A's bargaining power is weak. Such statements in themselves, however, reveal nothing of the strength or weakness of A relative to B, since B might similarly possess a strong or weak bargaining power. But if the cost to B of disagreeing on A's terms are greater than the cost of agreeing on A's terms, while the cost to A of disagreeing on B's terms is less than the cost of agreeing on B's terms, then A's bargaining power is greater than that of B. More generally, only if the difference to B between the costs of disagreement and agreement on A's terms is proportionately greater than the difference to A between the costs of disagreement and agreement on B's terms can it be said that A's bargaining power is greater than that of B.
In another formulation, bargaining power is expressed as a ratio of a party's ability to influence the other participant, to the costs of not reaching an agreement to that party:
- BPA(Bargaining Power of A) = (Benefits and Costs that can be inflicted upon B)/(A's cost of not agreeing)
- BPB(Bargaining Power of B) = (Benefits and Costs that can be inflicted upon A)/(B's cost of not agreeing)
- If BPA is greater than BPB, then A has greater Bargaining Power than B, and the resulting agreement will tend to favor A. The reverse is expected if B has greater bargaining power instead.
These formulations and more complex models with more precisely defined variables are used to predict the probability of observing a certain outcome from a range of outcomes based on the parties' characteristics and behavior before and after the negotiation. One potential application is in patent infringement lawsuits, when the jury must determine for the patent holder and the potential licensee a mutually-agreeable royalty for use of the patent holder's proprietary technology. One economist suggests a methodology to calculate the royalty whereby the total surplus of the transaction (or, the gains from trade generated when the patent holder successfully licenses its technology to the licensee) is calculated first, then split among the negotiating parties based on, in part, their relative bargaining power. The model explains that a patent holder with more bargaining power—for example, a patent holder that licenses its patents on an exclusive basis or that owns a commercially-successful technology—would capture a larger share of the total surplus than the licensee, and vice versa, as well as shows how that insight could guide a court's determination of a reasonable royalty in a patent infringement lawsuit.
Here is an example in layman's terms of one party displaying large amounts of bargaining power over the other:
- Stephanie is applying for a job at Company, Inc. Only one position is available, and there are 100 different people applying for that same position. Stephanie will not have choice between employers since Company, Inc is the only company hiring in her area. On the other hand, Company, Inc. will have a lot of choice, and will be in a position to offer Stephanie a standard form contract for employment, complete with minimum wage pay, nothing but workers compensation and unemployment as benefits, and the possibility for termination at any time, per the doctrine of at-will employment.
Buying power is a specific type of bargaining power relating to a purchaser and a supplier. For example a retailer may be able to dictate price to a small supplier if it has a large market share and or can bulk buy.
In modern economic theory, the bargaining outcome between two parties is often modeled by the Nash Bargaining solution. Suppose that party A and party B can collaborate in order to generate a surplus of 100. If the parties fail to reach an agreement, party A gets a payoff X and party B gets a payoff Y. Suppose that X+Y<100, so reaching an agreement yields a larger total surplus. According to the generalized Nash bargaining solution, party A gets X+π(100-X-Y) and party B gets Y+(1-π)(100-X-Y), where 0 < π < 1. There are different ways to derive π. For example, Rubinstein (1982) has shown that in a bargaining game with alternating offers, π is close to 1 when party A is much more patient than party B, while π is equal to ½ if both parties are equally patient. Note that party A’s payoff is increasing in π as well as in X, so both parameters reflect different aspects of party A’s power. To clearly distinguish between the two parameters, some authors such as Schmitz (2013) refer to π as party A’s bargaining power and to X as party A’s bargaining position. A prominent application is the property rights approach to the theory of the firm. In this application, π is often exogenously fixed to ½, while X and Y are determined by investments of the two parties.
- Kuhn, James W.; Lewin, David; McNulty, Paul J. (July 1983). "Neil W. Chamberlain: A Retrospective Analysis of His Scholarly Work and Influence". British Journal of Industrial Relations. 21 (2): 143–160. doi:10.1111/j.1467-8543.1983.tb00127.x.
- J. Gregory Sidak, Bargaining Power and Patent Damages, 19 STAN. TECH. L. REV. 1 (2015), https://www.criterioneconomics.com/bargaining-power-and-patent-damages.html.
- John Allen (2009). "Chapter 2 One-stop shopping". Making Social Lifes. Milton Keynes: The Open University. p. 66.
- Muthoo, Abhinay (1999). Bargaining Theory with Applications. Cambridge University Press.
- Binmore, Ken; Rubinstein, Ariel; Wolinsky, Asher (1986). "The Nash Bargaining Solution in Economic Modelling". The RAND Journal of Economics. 17 (2): 176. doi:10.2307/2555382. ISSN 0741-6261. JSTOR 2555382.
- Rubinstein, Ariel (1982). "Perfect Equilibrium in a Bargaining Model". Econometrica. 50 (1): 97–109. CiteSeerX 10.1.1.295.1434. doi:10.2307/1912531. JSTOR 1912531.
- Schmitz, Patrick W. (2013). "Bargaining position, bargaining power, and the property rights approach" (PDF). Economics Letters. 119 (1): 28–31. doi:10.1016/j.econlet.2013.01.011. ISSN 0165-1765.
- Hart, Oliver (1995). "Firms, Contracts, and Financial Structure". Clarendon Press.