Strategy and Negotiation
Negotiation and Game Theory
Negotiate as if your life depends on it
“The natural effort of every individual to better his own condition … is so powerful, that it is alone and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of surmounting a hundred impertinent obstructions with which the folly of human laws too often encumbers its operations.”
— Adam Smith, The Wealth of Nations
While dealing may involve some of the most high-pressure personal negotiations a dealer can face, negotiating involves the combination of many factors a negotiator can imagine. How do both sides manage conflict, create value, and successfully negotiate an agreement?
Well, Game Theory can clearly provide us an insight into what’s happening during a negotiation.
Consider this scenario.
Imagine you’re traveling to your college by an e-rickshaw and it’s raining. The driver asks for Rs. 30 instead of the usual fare of Rs. 10.
What negotiation might follow? At what price might the negotiation settle?
Is it Rs. 10? Rs. 15?
No.
Rs. 20, then?
Possibly.
Make the first offer
The first and foremost important rule of negotiation is that you must be the one to make the first offer. Since this opportunity is lost (the rider already asked for Rs. 30), you might offer Rs. 15 (you may recognize this tactic as following the minimax theorem). You have to start with a low respectable amount and only then are you left with a mediated equilibrium. As we all know at Rs. 15 the driver will straight away refuse, there are high chances that you pay the driver Rs. 20.
Minimax theorem is a simple but useful rule that can be applied to everyday situations. However, it’s problematic partly because it assumes perfect information. In the real world, things are much more confusing, not only because our negotiating opponent is rarely limited to two strategies, but also because there are many factors influencing our decisions.
Asymmetric Information
The most common situation that arises during a negotiation is known as asymmetric information and the way it works is the seller knows what the cost was to him and the buyer knows what the value is to him but they don’t know the costs or values of the other person.
In the example discussed above, imagine that a friend from another college decides to pay you a visit. It’s still raining, and since your friend is not aware of the usual charges, it is unlikely that they haggle for lower rates. And even if they do, they might be misled.
(Protip: Give your friend a call beforehand for the usual transportation rates.)
One of the examples showing the importance of asymmetric information is selling/buying on a platform like OLX. Suppose you come to know that the other guy from whom you are buying a product is desperate to sell it. In this case, you can settle the negotiation at a very low price. This kind of insider information plays a key role in negotiations.
Another example of asymmetric information is in labor economics. Labor economics focuses on the dynamics of the markets for wage labor. Consider a strike by the workers of a factory. The worker doesn’t know the value to the management of getting that strike done with and the management doesn’t know the cost to the worker of sitting out and striking. This private information leads to a world where straight-out bargaining will not lead necessarily to efficiency. Before going out for a straight bargain, the parties involved should look for other dimensions also which help them ascertain the position from which one party is dealing.
The real problem in a negotiation is to find out which things are relatively valuable to one person and relatively inexpensive for the other. Hence, one would be better off, if one looks at negotiation as a multi-dimensional process.
Two Sides of the Same Coin
To what extent can the players involved in a negotiation extract the full surplus out of the deal, especially when there is uncertainty and asymmetric information? The asymmetry in negotiations represents two sides of the same coin. Is it bad, as used in labor economics to explain strikes or a bit of a saving grace while making profits? Understanding the extent to which we want to allow markets to argue, to just work without mediation, the extent to which we want to intervene, when we want to intervene, how we want to intervene takes us back to basic economics.
The purpose of this article was to encourage you to seek the factors at play when you are asking permission for that sleepover or when a country refuses to return a refugee. When multiple parties are involved in a situation, it is more beneficial to think of everyone’s welfare, even if that means compromising a little.
References
- Game Theory and Negotiation (https://youtu.be/E1ifAXKDy0I)
- https://www.digitaltonto.com/2009/game-theory-guide-to-negotiations/
That’s all for today! Stay tuned for more interesting insights on how Game Theory affects all the decisions we make.
