142_15 - Vertical Supply Relationships Vertical Supply...

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ertical Supply Relationships Vertical Supply Relationships - Firm Boundaries and Vertical Pricing – What is a firm? – Why do firms exist? – What determines the size of a given firm? Villas-Boas – Lecture 15 EEP 142 Page 0
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The make or buy decision. Make: Vertical Integration Buy: Vertical separation nbranded Arco Content Unbranded Gasoline Refinery ontent Arco Branded Content Independent Station Distribution Distribution EEP 142 Page 1 Villas-Boas – Lecture 15
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Advantages of buying. EEP 142 Page 2 Villas-Boas – Lecture 15
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Advantages of making. – Facilitates coordination of the production process. – Incomplete contracts. – In the extreme, this is the “hold up” problem. acilitates price discrimination between downstream – Facilitates price discrimination between downstream markets. Next class. arketing efinery owned stations have a logo and – Marketing (refinery owned stations have a logo and advertise the gasoline brand). EEP 142 Page 3 Villas-Boas – Lecture 15
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Additional advantages of making. – Avoid market power in the upstream or downstream market. – Market foreclosure (next lectures). – Entry deterrence (next lectures). EEP 142 Page 4 Villas-Boas – Lecture 15
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Double marginalization. – Basic problem: each seller in the vertical chain ignores the effect of its markups on the profits of the other firms in the chain. – Example: think about two markets, one upstream from the other (e.g. retail and wholesale of gasoline). Retail level :M C : r = 1 Demand: Q = 10 – P r Wholesale level : MC: w =2 Demand: we will derive; sells to retailer at price P W and wholesale sales exactly equal tail sales. EEP 142 Page 5 retail sales. Villas-Boas – Lecture 15
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Double marginalization example (cont’). We will consider three cases: 1) Vertically integrated monopolist= Branded operated station with market power (e.g. only station in the area) 2) Competitive retail sector /monopolistic wholesaler (many tail stations in an area competing selling gasoline and retail stations in an area competing selling gasoline and buying gasoline upstream from only one refiner. 3) Monopolistic retailer/monopolistic wholesaler = the retailer is not owned by the brand and is operated separately having monopoly power (e.g. only station in the area) EEP 142 Page 6 Villas-Boas – Lecture 15
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1) Vertically integrated monopolist. – Monopolists MC = r + w = 1 + 2 = 3.
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142_15 - Vertical Supply Relationships Vertical Supply...

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