Monopoly not optimal from joint point of view a joint

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Unformatted text preview: from joint point of view (a joint vertical chain). chain In a vertical chain, profits would be In higher than the sum of individual profits of upstream and downstream firm. firm. Upstream firm (manufacturer) Downstream firm (Retailer) Consumers 11 11 Double Marginalization Vertical Vertical integration, i.e. the merger of the two firms, efficient as two they coordinate on optimal outcome i.e. they „internalize“ the externality they i.e. impose on each other. impose Also Also consumers gain from vertical merger! (price p will decrease) (price 12 12 Double Marginalization If If vertical integration is not possible, certain vertical restraints may be used: certain resale price maintenance: U iimposes p on mposes retailer, or establishes price ceiling retailer, Non-linear pricing (Franchise fee) 13 13 Resale Price Maintenance (RPM) Suppose Suppose the merger is not possible for whatever reason reason U can remove double marginalization by using can RPM (this is a „vertical restraint“) RPM U iimposes p_VI = (a+c)/2 on D. (Recall p_VI < p) mposes p_VI This also maximizes the surplus of the vertical This structure. structure. How the firms share the surplus will then depend on How w. w. If U has all bargaining power, it will impose w = p_VI If p_VI and get all the producer surplus. 14 14 Quantity fixing Equivalent Equivalent to RPM, U could also fix the minimum order of q that D has to purchase from U. purchase Then U would impose that D has to buy at Then least q_VI = (a-c)/2. q_VI Again, if U has all the bargaining power, it Again, will choose w = p_VI, and U will then also p_VI and appropriate all of the profit. appropriate 15 15 Non-linear pricing (franchise fee) fixed fixed component F plus variable component w for each unit. for retailer becomes „residual claimant“ of all profits generated in the market. profits Let Let w = c, retailer would behave as if it were vertically retailer integrated Retailer gets all the profits BUT: manufacturer could impose a „franchise fee“ F BUT: Profit_D = (p-c)(a-p)-F FOC FOC are not affected by inclusion of F, and thus the and solution would again be solution p_VI = (a+c)/2 and q_VI = (a-c)/2 16 16 Non-linear pricing (franchise fee) Distribution Distribution of profits again depends on relative bargaining power of firms relative Suppose there are many retailers they Suppose would outbid each other until F absorbs all profits manufacturers profits as if it owned the retailer (= vertical chain) the 17 17 If uncertainty is present… Non-linear pricing makes retailer react to demand or cost Non-linear shocks in the same way as vertically integrated firm shocks Retailer would be at high risk, a his profits are not protected Retailer against shocks against In order to insure him, manufacturer has to guarantee a certain In minimum profit minimum Resale Price Maintenance gives perfect insurance under Resale demand uncertainty, but is bad under cost uncertainty, as shock in w will greatly affect profits of retailer. as RPM better under demand uncertainty, non-linear pricing...
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