ECONOMY

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The demand bargaining approach in the study of coalition government is due
to Morelli (1999). In Morelli’s approach agents do not make sequential offers (as in
the Baron–Ferejohn model), but make sequential demands, i.e. compensations for
their participation in a given coalition. Specifically, the head of state chooses the first
mover. After that, agents make sequential demands until every member has made
a demand or until a majority coalition forms. If no acceptable coalition emerges
after all players have made a demand, a new first demander is randomly selected;
all the previous demands are void, and the game proceeds until a compatible set of
demands is made by a majority coalition. The order of play is randomly determined
from among those who have not yet made a demand, with proportional recognition
probabilities. 19
To see the difference from the Baron–Ferejohn model consider the three-party
example as above. Morelli (1999, proposition1) shows that in this case the distribution
of benefits is ($1/2, $1/2) among some two-party coalition. In contrast to the
Baron–Ferejohn model there is no proposer premium. Intuitively, each party has the
same bargaining power in the demand bargaining game and that is reflected in
the equilibrium outcome.
An alternative approach was proposed by Merlo (1997) based on the work of Merlo
and Wilson (1995). As in the original Baron–Ferejohn model and in Morelli’s model,
a set of players bargain over a perfectly divisible payoff by being recognized and
then making offers. If the offer is accepted by all parties, the government forms; if
not, bargaining continues. However, there are two key differences. First, all players
need to agree to a proposed distribution. Second, the value of the prize changes
over time. Merlo interprets this change as shifting common expectations about the
lifespan of the chosen coalition caused, for example, by shifting economic indicators
(e.g. Warwick 1994). Merlo and Wilson (1995, 1998) show that this game has a unique
stationary subgame perfect equilibrium. 20 Second, the equilibrium of the bargaining
game satisfies the so-called separation principle: anyequilibriumpayoff vector must
be Pareto efficient, and the set of states where parties agree must be independent
of the proposer’s identity. A very rough intuition for the result is that because all
members of the coalition need to agree to an allocation, the coalition behaves as if
it desired to maximize the joint payoff. Withchangingpayoffs this implies that for
some states the parties would be better off to delay agreement to wait for a better
draw. Therefore, bargaining delays can occur in equilibrium. 21 In contrast to earlier
accounts (e.g. Strom 1988) that had interpreted long formation times as evidence of
a crisis, Merlo and Wilson showed that delays may be optimal from the point of view
of the bargaining parties. By not agreeing immediately (and thus forgoing a higher
¹⁹ Earlier models of demand bargaining used an exogenous order of play. See e.g. Selten 1992; Winter
1994a, 1994b.
²⁰ Both unanimity and randomly changing payoffs are important for both the uniqueness result and
the efficiency property (Binmore 1986; Eraslan and Merlo 2002). Majority rule, for example, leads to
multiple equilibria and inefficiency. Parties agree “too early” to ensure that they will be included in the
final deal.
²¹ For an empirical studies of the cabinet formation processes see Diermeier and van Roozendaal
1998; Diermeier and Merlo 2000; Martin and Vanberg 2003.