Suggested versus Extended Gifts: How Alternative Market Institutions Mitigate Moral Hazard

Gift exchange can partially mitigate supply-side moral hazard, even in anonymous market interactions. In a market where quality is not fully contractable, the amount that a price exceeds the market-clearing price for the lowest quality is a gift from the buyer. We show that the gift formation process, inextricably linked with a market institution’s price formation process, greatly influences the size and effectiveness of the gift. When the market institution dictates that prices are formed by bids posted by buyers, the gift is extended to the seller. When the market institution dictates that prices are formed by offers posted by sellers, the gift is suggested by the seller. We conjecture that extended gifts do not instill as strong a concern for the material welfare of the other party as suggested gifts. We show in experiments that this effect is quite profound in both monopsonist and thick markets. Posted offer markets generate higher prices, in turn larger gifts, and higher levels of product quality than posted bid ones. In addition, the posted offer institution generates a higher quality given the price, rather than simply generating higher prices. Both sides of the market obtain higher payoffs under posted offer institutions