The paper analyzes repeated contract negotiations involving the same buyer and seller where the contracts are linked because the buyer has persistent (but not fully permanent) private information. The size of the surplus being divided is specified as a two-state Markov chain with transitions that are synchronized with contract negotiation dates. Equilibrium involves information cycles triggered by the success or failure of aggressive demands made by the seller. Because there is persistence in the Markov chain generating the surplus, a successful demand induces the seller to make another aggressive demand in the next negotiation, since the buyer's acceptance reveals that the current surplus is large. Rejection of an aggressive demand, on the other hand, leads the seller to be pessimistic about the size of the surplus in the next contract, so the seller makes a "soft" offer that is sure to be accepted. Then, after several such offers have been accepted, the seller is optimistic enough to again make an aggressive demand, creating an information cycle. An interesting feature of this cycle is that the soft price is not constant, but declines as the cycle continues, so as to offset the buyer's option value of re-starting the cycle when the current state is bad. An explicit mapping is given for the relationship between the basic parameters and the equilibrium prices and quantities; in particular, there is a closed-form solution for the threshold belief that makes the seller indifferent between hard and soft offers.
JEL No: C7.
Keywords: Repeated Bargaining, Private Information, Learning
Final Version (September 2000)
November 1999 revision
Previous versions
April 97 version (Acrobat format)
"Informational Rents in Bargaining with Serially Correlated Valuations," December 1998. Incomplete