SALLY BLOUNT-LYON EXPLAINS THAT WHILE MARKETS MAY BE EFFICIENT,
THEY AREN'T ALWAYS FAIR.
ONE OF THE most common misconceptions that many otherwise intelligent
prey to is that markets are fair. I cant tell you how many times
my students have told me that, Ive heard politicians say it,
and Ive read it in popular press articles. Yet that notion
is simply wrong.
Using markets as a means of distributing goods and services can
assure that the maximum possible number of beneficial transactions
will take place. Thats what social efficiency means. However,
efficiency has little to do with assuring that peoples needs
are met in a fair and just way.
Markets are efficient
The notion of fair markets stems from the idea of fair pricing.
A price, of course, is nothing more than the dollar value that
a buyer agrees to give a seller and a seller agrees to take in
exchange for providing a good or service. In any price transaction,
there are typically a range of prices at which a buyer and seller
can agree, at which both would be happy to trade. When parties
agree on a price that falls below the most that the buyer is willing
to pay and above the least that the seller is willing to accept,
theyve got a deal.
These respective values are referred to as each partys reservation
price (RP). Together, RPs set the boundaries of what we in the
negotiations business call the bargaining zone, or the zone of
possible agreement (ZOPA). Whenever the bargaining zone, or ZOPA,
is positive (i.e., greater than zero), trade should occur. There
is value to exchange; both parties are better off trading than
not. This is because each party can, in theory, reach an agreement
that is better than their reservation price. Conversely, whenever
the bargaining zone, or ZOPA, is negative, trade should not occur.
Both parties are worse off trading than not.
To make this concrete, lets consider an example. Jane is selling
Penny a used stereo. Jane
is willing to go as low as $105. Penny is willing to go as high
as $120. Thus, the sellers reservation price is $105, and the
buyers reservation price is $120. The bargaining zone is between
$105 and $120. If Jane and Penny agree to trade, the price will
fall somewhere in
Note that in this model any price that falls within the bargaining
zone is acceptable and expected. There is no right or "fair" price
by definition. Any price that meets or beats
both bargainers reservation prices is fine. Each negotiators
tactical goal is to settle as far away from his or her reservation
price as possibleto claim as much of the excess surplus
Now, a market is what we get when we look at buyers and sellers
at a system level. Beginning with the bargaining zone model, we
rotate price from the horizontal axis to the vertical axis, and
put quantity on the horizontal axis to represent the full volume
of possible trades. Often we can define the demand curve as consisting
of all buyers reservation values arranged in descending order.
Likewise, the supply curve can consist of all sellers reservation
values arranged in ascending order. Thus, the buyer with the highest
reservation price starts out the demand curve, as does the seller
with the lowest reservation price. The vertical distance between
the two points represents the bargaining zone that would be available
if those two traders met in the market.
Of course, markets are typically not that orderly. Buyers and
sellers match up in a more randomized manner, and the bargaining
zone changes from transaction to transaction within a market.
For example, in the figure below, the buyer depicted at point
A may meet up with a seller depicted at point B or C.
By definition, efficiency happens when social welfare is maximizedwhen
there is no way to make someone in the economy better off without
making someone else worse off. In markets, that means that for
all possible combinations of traders, every possible combination
that involves a positive bargaining zone takes place. From theory,
we know that so long as markets are characterized by perfect competition,
the market clearing price is efficient. Any seller with a reservation
price below that point is willing to trade, as is any buyer with
a reservation price above that point. All mutually beneficial
trades that can occur do occur, and we maximize utility. Thus,
economic theory tells us that free, unfettered, perfectly competitive
markets are the most efficient way to allocate goods and services.
Recent economic history certainly seems to bear that out.
But are markets fair?
Theory tells us that markets are efficient, but are they fair?
Before we can assess that, we first have to have some understanding
of what being fair means. It turns out that this is more easily
said than done. (Try to come up with a simple definition of fairness
and youll see.) It is a topic that many researchers in both psychology
and economics have pondered of late.
The whole idea of fairness appears to emanate from social comparison
processes and the need for predictability in life. People dont
like to feel exploited, to be thought of as suckers, to be uncomfortably
surprised in social settings. People do like to feel valued, respected,
and in control. Yet satisfying that need set is complex, because
life truly isnt "fair." There are seldom the resources or time
necessary to address each need for each person in a social situation.
Thus, our efforts at being fair to others or being treated fairly
by others are always imperfect.
Fairness, in part, can be thought of as a judgment that people
make regarding social outcomesthat is, how benefits and payoffs
get distributed across people within an interaction. In these
contexts, fairness judgments represent the degree of equality
or inequality across parties payoffs that is considered acceptable
within a given situation. As an example, people often think of
even splits as fairespecially among friends. "Well split the
tab 5050." In business, people often define fairness in terms
of equity, in proportion to earned rights or inputs. Those who
contribute more, in terms of investment or generating sales or
profits, get more out in terms of financial rewards. Sometimes
when goods cant be divided, people consider chance outcomes to
be fair; many times people will agree that whomever wins the coin
flip gets the prize. Across all of these examples, fairness norms
help organize expectations about which social outcomes are considered
normatively appropriate or acceptable.
From psychological research, we know that people not only value
fair outcomes but they also value the actual experience of being
treated fairly. We like it when others are respectful to us, when
others consider our point of view, when things go the way that
we expect them to. Thus, people also value fairness in process,
as well as outcomes, and apply norms of procedural fairness to
make these judgments.
From a procedural perspective, there are some aspects of markets
that appear fair and some that dont. For example, one of the
fair aspects of markets is that they allow everyone equal access.
Typically anyone can participate, regardless of gender, race,
religious orientation, etc. On the other hand, this access has
an income bias. The way that people participate is through economic
currency. Presumably, buyers who have more money can afford to
pay more for goods; they are more likely to be both willing and
able to pay for goods at or above the market clearing price. Thus,
those who have more get more in a market system. Im not sure
Regarding outcome fairness, I often ask my students, "Will someone
please tell me whats fair about settling at the market clearing
price? It is certainly efficienteconomic theory and experience
show us that it maximizes utility. But will someone please tell
me whats intrinsically fair about the point at which these two
theoretical curves intersect?" Usually the class gets pretty quiet.
"Besides," I continue, "theres no such thing as a market clearing
price." In practice, we dont map out supply and demand curves
in real time and calculate the point at which they intersect.
Instead, before negotiating, we collect recent market price data.
This data tells us what other people have paid for a similar good
or service. In "thick" markets like stock exchanges, where trades
occur frequently and information is readily accessible, prices
converge, as theory would predict. There is little variance. In
"thin" markets, such as housing within a neighborhood, trades
occur every few weeks at the most and it is difficult to reliably
define an absolute market price. Here, people think more in ranges.
When we identify a market price (or range of prices) from this
data, many people like settling at that price because they think
its "fair." Yet, while convergent pricing within a market may
feel good, it does not necessarily translate into fair outcomes
in terms of allocating economic surplus. As an example, in the
case of monopolies, prices maybe equal, but the seller is garnering
all of the bargaining zone surplus away from the buyers. Whats
fair about that?
I often think what people like about the notion of convergent
or equal pricing is process-oriented. It appeals to our sense
that equality is good, that every buyer/seller is getting a similar
deal. It also feels safe, because we know that others settled
at the same place we didso if later, we learn of a better deal,
we dont need to feel as bad, if were in the same boat with others.
From an interactive perspective, settling at market price has
a "warm" feeling to it. Price negotiations are by nature conflictual.
Yet, in the presence of straightforward market data, both parties
agree to settle at the market price, feel good about it, and move
on to something else.
Fairness as a motivater and a blocker
It is my sense that fairness and social comparison processes are,
in part, what drive market behavior. I would suggest that the
psychological energy behind routine market search and negotiation
behavior is not simply utility maximization and the desire to
do better than your reservation price. It is also the desire to
not come up short compared to others. As buyers, we like to do
as well as or better than other buyers in a market, and to feel
that sellers are not exploiting us.
For example, we dont like learning that our neighbor just bought
the same car that we did at the same dealership for $500 lesseven
if the price we paid fell below our reservation price. First,
we dont like learning that we are not as good at negotiating
as our neighbor, and second, we dont like feeling that the dealer
took us for a "sucker." Thus, in many ways, market convergence
is borne of social comparison and fairness concernsboth as we
compare ourselves to other buyers or sellers in our same situation
and as we reflect on how the other party in a transaction is treating
However, as such, fairness concerns can also be a source of trade
inefficiency. There is considerable evidence that finds that people
will remain at an impasse rather than accept what they perceive
to be an "unfair" deal, even if that outcome exceeds their reservation
price. Consider, for example, my research with Maggie Neale of
Stanford, in which we have demonstrated the common intuition that
more extreme opening offers can move outcomes in a direction favorable
to the party making them. In other words, "high-balling" or "low-balling"
can have the desired effect. We have also demonstrated empirically
that extreme opening offers introduce a big risknamely, the likelihood
of impasse. This is because people care about fairness in concession
making. If one partys opening offer is much farther away from
the bargaining zone than the others, that party will have to
make much bigger concessions to move into the zone of possible
agreement. The negotiator who consistently makes bigger concessions
often feels that they are not being respected or appreciated.
He or she wants to see reciprocation from the other side. But
the other side cannot reciprocate to the same magnitude because
they dont have as much room to play. As a result, such negotiations
result in impasses much more frequently, even though economic
theory says they shouldnt because the bargaining zone is positive.
To make this concrete, lets return to Jane and Penny. Imagine
that Jane has stated an opening offer of $150 (recall that her
reservation price is $105), and Penny has countered with $100
(her RP is $120). Jane comes down to $140. Penny comes up to $110.
Jane then goes to $130, and Penny balks. She says that she can
only come up to $115. Jane says, "Okay, I can go as low as $125,
but thats it," figuring that she has been quite reasonable. Penny
responds, "Sorry, I cant do it." At that, Jane walks away thinking
that Penny has been unreasonable, when, in fact, given her reservation
price, Penny has not been.
On the other hand, if Jane had started at $125, the problem is
likely to never have arisen, and the deal would have been made.
In both cases, from an economic perspective, the deal should have
taken place. In both cases, there would have been surplus created
In real life, prices happen through trade. The "market price"
represents data about the prices others have recently paid to
purchase a similar good or service. This price may or may not
fall at the market clearing pricethe point where the theoretical
supply and demand curves meet.
Markets are efficient. Markets are incredibly powerful. In fact,
they are unmatched in their ability to organize people and resources,
aggregate information, and create utility in complex social contexts.
However, if fairness is your concern, markets are not that. There
is nothing inherently fair about supply and demand or market clearing
prices. And while market price information may provide a reasonable
standard for resolving a price negotiation, it, too, is not inherently