Bargaining with a Customer

Customer either willing to pay $20

or $10, equally likely
Your price is $15 (zero costs), but
customer asks for a deeply
discounted price of $5
You don’t know whether the
customer has value $20 or $10

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 Bargaining with Customer
“Nature” Buy 15, 5
moves first Don’t

Don’t 0, 0
High Value
Give
(prob p) 5, 15
Discount
Buy
15, -5
Don’t
Low Value
Don’t 0, 0
(prob 1-p)
Give
5, 5
p = 50% Discount

Information set represents that seller can’t

distinguish whether buyer has high or low value
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Solving for “Sequential Eqm”
Buy 15, 5
Don’t

High Value Don’t

Give
(prob p) 5, 15
Discount
Buy
Don’t
Low Value
Don’t 0, 0
(prob 1-p)
Give
5, 5
Discount

Seller’s equilibrium choice depends on its belief about

likelihood of High Value vs. Low Value
• By Don’t Discount, seller is “risking 5 to gain 10”
• Don’t Discount if p > 1/3
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Other Approaches?

If a customer “pleads poverty” for a

discount, you have other options
than simply to grant/refuse request

What else might you do?

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Clearance Sale
15, 5
Product only
No Sale available
Sale with prob. q
Value 20 5, 15
for those
(prob p) Buy Now
who Wait
Clearance (q) 14, 5

Wait 5q-1, 15q

0, 0 Running the
No Sale
Value 10 Clearance
(prob 1-p) Sale 5, 5 Sale costs 1

Buy Now
Clearance (q) -1, 0

Wait 5q-1, 5q
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Clearance Sale as Screen
No Sale 15, 5

Sale
Value 20 5, 15

(prob p) Buy Now

Clearance (q) 14, 5

Wait 5q-1, 15q

0, 0
No Sale
Value 10
(prob 1-p) Sale 5, 5

Buy Now
Clearance (q) -1, 0

Wait 5q-1, 5q

Clearance is an effective screen if q < 1/3

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Clearance Sale?
Clearance Sale Clearance Sale
or Sale? or No Sale?

1/3 p = Pr(High)

p > 1/3: No Sale better than Sale

p < 1/3: Sale better than No Sale

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When (not) to have
Clearance Sale (p < 1/3)
Clearance Sale Clearance Sale
or Sale? or No Sale?

1/3 p = Pr(High)

Clearance Sale vs. Sale

Clearance gives +9 more on High
Clearance loses 1 + 5(1-q) on Low

Only have Clearance when chance of High

is sufficiently large
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When (not) to have
Clearance Sale (p > 1/3)
Clearance Sale Clearance Sale
or Sale? or No Sale?

1/3 p = Pr(High)

Clearance Sale vs. No Sale

Clearance gives –1 + 5q more on Low
Clearance loses 1 on High

Only have Clearance when chance of High

is sufficiently low
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When to have
Clearance Sale (p = 1/3)
Clearance Sale Clearance Sale
or Sale? or No Sale?

1/3 p = Pr(High)

If Clearance is ever your best strategy, it

must be when you are indifferent
between Sale and No Sale (p = 1/3)
“when you can’t decide whether to offer a
High- or Low-Quality product, offer both!!”
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Versioning

Suppose that high-quality/high-cost

item will be equally profitable as
low-quality/low-cost item

In this case, you can always do

better offering a menu of both items
that acts as a consumer screen

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Versioning: Example
Customer
willingness
GOOD BAD
-to-pay
PRODUCT PRODUCT
HIGH
$35 $20
CUSTOMER

LOW $20 $15

CUSTOMER

Good product costs $5, bad product $0

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Versioning: Example
GOOD BAD
PRODUCT PRODUCT
HIGH
CUSTOMER $35 $20

LOW $20 $15

CUSTOMER

Sell only Good 2*($20-$5) or ($35-$5)

Sell only Bad 2*($15-$0)
Sell both ($15-$0) + ($30-$5)
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 Good-quality vs. Bad-quality
$35 $35

$20 or $20

$15 $15

Good-quality Bad-quality Menu of

only only both
= Consumer surplus = Profit = Cost
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Summary
Strategic issues arise when different
players have different information
Moral hazard given hidden action
role for incentives / tying one’s hands

Adverse selection given hidden trait

role for screening / signaling

Next time: using hidden traits about

yourself to make a credible commitment
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