ch18 - Vertical Price Restraints Chapter 18: Vertical Price...

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Chapter 18: Vertical Price Restraints 1 Vertical Price Restraints
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Chapter 18: Vertical Price Restraints 2 Introduction Many contractual arrangements between manufacturers Some restrict rights of retailer Can’t carry alternative brands Expected to provide services or to deliver product in a specific amount of time Some restrict rights of manufacturer Can’t supply other dealers Must buy back unsold goods Some involve restrictions/guidelines on pricing
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Chapter 18: Vertical Price Restraints 3 Resale Price Maintenance Resale Price Maintenance is the most important type of vertical price restriction Under RPM agreements retailer agrees to sell at manufactured specified price RPM agreements have a long and checkered history In US, Miles Medical Case of 1911established per se illegality for any and all such agreements However, Colgate case of 1919 allowed some “wiggle room” Miller-Tydings (1937) and McGuire (1952) Acts even more supportive in allowing states to enforce RPM contracts Repeal of Miller-Tydings and McGuire Acts reverted legal status back to (mostly) per se illegal State Oil v. Khan decision in 1997 allowed rule of reason in RPM agreements setting maximum price
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Chapter 18: Vertical Price Restraints 4 RPM Agreements & Double Marginalization Recall the Double Marginalization Problem Downstream Demand is P = A – BQ and Retailer has no cost other than wholesale purchase price Downstream Marginal Revenue = MR D = A – 2 BQ MR D =Upstream Demand Upstream Marginal Revenue = MR U = A – 4 BQ With Manufacturer’s marginal cost c , profit- maximizing output and upstream price are: Downstream price is: ( 29 B c A Q 4 - = ( 29 2 c A P U + = and ( 29 ( 29 4 3 2 c A B r A P D + = - =
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Chapter 18: Vertical Price Restraints 5 RPM & Double Marginalization (cont.) With a vertical chain of a monopoly manufacturer and a monopoly retailer, the downstream price is far too high There is a pricing externality The manufacturer profit is the wholesale price r cost c times the volume of output Q [= ( r – c ) Q ] Once r is set, manufacturer’s profit rises with Q In setting a markup over the wholesale price, the retailer limits Q and cuts into manufacturer profit But retailer ignores this external effect Retail (and wholesale) price maximizing joint profit ( 29 2 * c A r P + = = < Independent retailer’s price
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Chapter 18: Vertical Price Restraints 6 RPM & Double Marginalization (cont.) An RPM restriction that prohibits the retailer from selling at any price higher than P* would permit the manufacturer to achieve the maximum profit There is though an alternative to the RPM, namely a Two-Part Tariff of the type discussed in Chapter 6 Set wholesale price at marginal cost c Retailer will then choose P D = P* = ( A + c )/2 and earn profit = ( A – c ) 2 /4 B 2
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Chapter 18: Vertical Price Restraints 7 RPM & Price Discrimination An RPM to prevent double marginalization suggests problem is that the retail price is too high
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ch18 - Vertical Price Restraints Chapter 18: Vertical Price...

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