Hard Bargains and Lost Opportunities

A long tradition in economics assumes that any potential gains from trade will be exploited. This emphasis on efficiency clashes with the possibility that hard bargaining over the division of the surplus may cause some potential deals to be lost. We examine an Outside Option Game designed to study the tension between maximising the size of the surplus and bargaining over the division of this surplus among those who contributed to its creation. An experimental study confirms that subjects often fail to achieve efficient outcomes. A theoretical model accounts for this behaviour in terms of an equilibrium achieved in an imperfect world