make direct use of the equipment and machinery inventory. The buyer has
examined the warehouse and contents and, after considerable figuring, has esti-
mated its value for the transaction at $600,000; that is, the potential buyer is
indifferent to the options of paying $600,000 to complete the purchase or for-
going the transaction altogether. The seller sets its value for the transaction at
$520,000; this is the net amount the firm estimates it would obtain, on average,
from selling the warehouse and contents via a broker or at auction. The buyer
and seller values are referred to as reservation pricesor walk-away prices.
Given the values held by buyer and seller, it is evident that a mutually ben-
eficial agreement is possible. In particular, both parties would prefer an agree-
ment at a price between $520,000 and $600,000 to the alternative of no
agreement at all. For convenience, we denote the sale price by P. The seller’s
profit from such a transaction is P $520,000, whereas the buyer’s gain is
$600,000 P. If there is no agreement on a price (and, therefore, no sale), each
party earns zero profit. Clearly, any price such that $520,000 P $600,000
affords positive profits for both parties. This price range between the buyer and
seller walk-away prices is referred to as the zone of agreement. Observe that the
total gain (the sum of buyer and seller profit) from such a transaction is.The total gain (or trading gain) is measured by the difference between the
buyer and seller values, that is, the size of the zone of agreement.
Figure 15.1 presents two views of the buyer-seller transaction. Part (a) shows
the zone of agreement and possible negotiated prices within it. A price of
$540,000 is shown at point A. At this price, the buyer claims $60,000 in profit
and the seller claims $20,000. Obviously, at higher negotiated prices, the seller’s
profit increases and the buyer’s profit falls dollar for dollar. Part (b) displays
this profit trade-off explicitly. The parties’ profits from transactions at various
prices are graphed on the axes. The profits from a $540,000 price appear at
point A. Prices of $560,000 and $580,000 (and the corresponding profits) are
listed at points B and C, respectively. The downward-sloping line shows the
profit implications for all possible prices within the zone of agreement. This is
commonly called the payoff frontier. If the parties fail to reach an agreement,
they obtain zero profits, as marked by point 0 at the origin of the graph.
Figure 15.1 reemphasizes a simple but important point about the gains
from a negotiated agreement. An agreement at any price between $520,000
and $600,000 is better for both parties than no agreement. The “no agreement”
outcome is said to be inefficientbecause there exists one or more alternative
outcomes that are better for both parties. We say that an outcome is efficient if no
other outcome exists that is better for both parties.^1 By this definition, all of the out-(600,000P)(P520,000)600,000520,000$80,000
632 Chapter 15 Bargaining and Negotiation(^1) More accurately, an agreement is efficient if there is no other agreement that makes one party bet-
ter off without making the other worse off.
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