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Efficient Bilateral Negotiation

By Milan Horniaček

Abstract

The paper analyzes a negotiation between two players (e.g. finns in duopoly wishing to fonn a cartel or countries involved in a trade dispute) about levels of their activities that may be hannful to the other player. Negotiation takes place in discrete time, with alternating offers of the two players, and it can last forever. Until the players reach an agreement, they can freely choose levels of their activities. Once the agreement is reached, it is binding. The negotiation process is modelled by a noncooperative extensive fonn game. The analysis concentrates on Markov perfect equilibria, i.e. sub game perfect equilibria in Markov strategies. These strategies prescribe the same behavior in all subgames that are strategically equivalent. When players use Markov strategies, their current moves (actions taken, proposals in negotiation, and reactions to rival's proposals) do not depend on past moves of any of them that do not affect payoffs of at leastone of them from current or future moves. In each Markov perfect equilibrium the players reach an agreement on a pair of activities, which gives Pareto efficient vector of payoffs, in the first round of negotiation.bilateral negotiation, extensive fonn game, Markov perfect equilibrium, Markov strategy, Pareto efficient agreement

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