Ways to Expand the Pie

.2 Ways of Expanding The Pie

What can be done to make sure that the strategic interaction between agents does not shrink the pie? It is tempting to propose that agents should get together and decide to co-operate. Suppose they actually did. Let us imagine in the “pricing in a channel” example, the manufacturer is able to persuade the retailer to charge p* and promise to pay the retailer (p** - w) S** where S** = A – B p**. In other words, they would have to agree what price the retailer would charge and then, after sales are realized the manufacturer would pay a promised amount. Although this is possible in the simple example at hand it may be harder to come to such an agreement in complicated real world situations. For example actual sales may deviate from expected sales, and so to make sure the retailer actually charged the price p* the manufacturer may have to incur a cost to monitor the retailer. After sales are realized, if they are higher (lower) than expected sales the retailer may demand higher (the manufacturer may offer a lower) payment! This could means that the retailer may seek upfront payment while the manufacturer may prefer a payment after sales are realized. We can see that expanding the pie still requires us to specify how the pie will be divided. And agents are likely to compete hard to get their share.

.2.1 Contracts

Strategic agents can enter into contracts that are legally enforceable to maximize the size of the pie. An important consideration in making sure that the contract is enforceable is whether or not a third party (judge) can verify if each party actually undertook what they promised to do. For example, it would be hard to prove that a person broke a promise to work hard. All that we might be able to do is to make sure that the person punches a clock and in this way monitor the time spent on work. Another consideration is that the contract itself must be acceptable to each agent. After all, one or the other agent can refuse a...