In a recent video Gulnara gave us some background of haggling in the former Soviet Union, and we tried to understand some of the way we could evaluate whether it is “good or bad” beyond the standard “haggling allows for optimal price discovery” vs “haggling adds transaction costs to trading”. The video can be found here.
For those who don’t like video and just want to read the text, it can be found below.
On a recent trip to my beautician – link to her website below – I started negotiating the price of my visit. However, I quickly caught myself doing so and stopped. She understood where I was coming from, as she is also from the former Soviet Union, where such haggling is a normal part of daily life. But that isn’t the case in a country like New Zealand – which is why we both put a stop to it.
So why is haggling culture so different in different countries, and what are the economic consequences of this?
That is really interesting Gulnara. Such bargaining does depend on the expectations of consumers and producers – so bargaining cultures will tend to support individuals bargaining while societies that do not do that will make it costly.
This strategic complementarity implies that both societies with bargaining and those without are “equilibrium” outcomes – where people’s incentive is to do what everyone else is doing. We call these bargaining and non-bargaining equilibrium “states of the world”.
To evaluate these outcomes, we want to think more deeply about price setting and market structure within each of these states. Then we can posit ways to test this with data, and also think about how differences in the data between countries may be due to the acceptance of bargaining.
The two mechanisms we will focus on here are price discrimation and tacit collusion and price discovery.
Retail stores tend to be monopolistically competitive – especially at the stage where you have already turned up at the store ready to purchase.
When you are at a store and ready to purchase you have three options: Don’t purchase, purchase at the ticket price, and haggling. In the face of haggling the store has its own incentive to haggle back – or to tell you to get bent.
The willingness to haggle on both the customer’s and the firm’s behalf depends on whether it is something they expect other people to do – it feels pretty stink to go and haggle just for the other person, and other customers, to look down their nose at you. However, this is more than just some concern about underlying social judgment – the act of haggling is something the firm would like to be prepared for, and the act of undertaking haggling puts pressure on these other customers to take on the cost of haggling themselves.
This can all be articulated through the concept of price discrimination.
Price discrimination is an interesting issue. A big reason why we viscerally feel uncomfortable with it is because it is discrimination – two people are being charged a different amount for exactly the same product! This seems fundamentally unfair.
In this haggling case, such discrimination doesn’t work by having a price and marking it up for some and down for others. Firms, in the face of bargaining, will increase the ticket price relative to a situation without bargaining. This will make it necessary for customers to negotiate simply to receive the price they would receive in the absence of such bargaining.
As a result, if you are not equipped to bargain, you end up paying higher prices – and if you aren’t able to negotiate much, this may be due to it being costly for you to negotiate, making the “real price” paid high.
However, there are those that benefit. Customers that are able to buy who wouldn’t have been able to at the non-price discrimination price, those with a low willingness to pay (or low cost for bargaining) will experience lower prices, and the business is able to increase their profits. Overall it might be more economically efficient, depending on how costly haggling is to individuals, but there may be distributional concerns.
If the industry is fully monopolistically competitive, low entry barriers will see the increase in business profits evaporate – so the increase in sales will lead to an increase in benefits to consumers on average, although at the cost of customers who have a high willingness to pay/low willingness to bargain. Furthermore, such entry may lead to excessive product variety as noted in Li and Shuai (2019) Monopolistic competition, price discrimination and welfare – ScienceDirect.
The mixture of price discrimination and search costs doesn’t just hold in the abstract. Bryne, Martin, and Nah (2019) (negotiation_v18.pdf (nyu.edu)) is a recent example of a field experiment testing out this behaviour and its implications. However, these implications and what we think about them does depend on the reason why “willingness to pay” is high and why “search costs” or “the cost of bargaining” may be high.
If it was just on the basis of individuals initial income, this may be quite redistributive – increasing provision of the product and the welfare of low income individuals. However, if it was due to the necessity of provision to meet minimum standards (i.e. health care expenses) such bargaining may be quite regressive.
Gulnara, you’ve actually experienced life with bargaining and life without – why don’t you tell us your thoughts.
When I was a teenager I was still getting used to being able to shop for myself. At the time I didn’t really understand haggling, and as a result I found it quite exhausting.
I specifically remember going and purchasing sunglasses from a store in Baku, that I thought looked very cool.
I went home with them, and my mom asked me how much they cost – I told her and she inquired whether I had managed to get a discount. When I told her I just paid the ticket price, she laughed and took me back to the store, haggling with them for a discount to be paid back to me. The point of the lesson was to indicate that even if you were willing to pay for a given product, prices had been inflated – and so bargaining was expected.
As I got older, bargaining was active in certain situations – and it became more natural and less costly for me. Haggling with doctors for medical treatment and check-ups was extremely common, and once I left Azerbaijan to study in Italy, there were constant situations where bargaining was necessary – and expected – to live on my limited student budget.
Tacit collusion and price discovery
Now I’d like to change tack a little bit. Although bargaining may be a tool for price discrimination, it also influences the nature of competition in the market.
We recently talked about tacit collusion when chatting about Nurofen prices. Furthermore, an understanding of tacit collusion helps us to understand economic cycles and the recent discussion about price freezes – something we’ve blogged on.
What does this have to do with tacit collusion? Well when comparing the Rotemberg and Saloner model to the Green and Porter model we noted that a major issue was that of “information”. Can a firm tell whether their competitors are to blame for changing prices?
If, instead of monopolistic competition, we had firms that were oligopolistic then these strategic interactions become important for the general level of price setting.
Having bargaining, offers an “unobservable” way to cut or increase prices. As a result, your firm’s competitors may be able to observe the ticket price on what you sell – but they cannot observe the full complexity of how you will discount to attract customers.
This view of collusion and bargaining implies two things.
Firstly, with less information about the price set by the other firm, the Green and Porter model – where there are price wars in low demand states – becomes a more believable representation of price setting. As a result, pricing dynamics over the economic cycle may look quite different in countries with significant consumer bargaining.
Secondly, as it is harder to observe the other businesses’ prices and build up trust for collusion, it is more difficult for firms to collude! In countries where bargaining does not occur, firms can loudly commit to a certain level of prices, and thereby find ways to tacitly collude and keep prices higher.
As a result, profit margins and prices would be higher in countries where bargaining is culturally uncomfortable – countries like New Zealand, Australia, and the United Kingdom. These example countries are fairly well known for being “expensive” to live in – so consumer bargaining may be one possible explanation. However, this is an issue we are going to discuss more deeply another time.
To sum up, with price discrimation and tacit collusion, we’ve outlined two of the possible mechanisms that may differentiate market outcomes in countries with active market bargaining and those without. Both of these arguments appeared to show bargaining in a favourable light – however, they also did point to trade-offs that may reverse this, namely the cost of bargaining, the proliferation of excess product variety, and broader related distributional consequences.
However, there are other possible arguments that can come to mind. If you have some alternatives of your own, why don’t you pop them down in the comments for us all to discuss!
Thanks for watching and we’ll see you next time.