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Unformatted text preview: from joint point of view (a
In a vertical chain, profits would be
higher than the sum of individual
profits of upstream and downstream
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
impose on each other.
Also consumers gain from vertical merger!
(price p will decrease)
12 Double Marginalization If
If vertical integration is not possible,
certain vertical restraints may be used:
certain resale price maintenance: U iimposes p on
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
RPM (this is a „vertical restraint“)
U iimposes p_VI = (a+c)/2 on D. (Recall p_VI < p)
mposes p_VI This also maximizes the surplus of the vertical
structure. How the firms share the surplus will then depend on
w. If U has all bargaining power, it will impose w = p_VI
and get all the producer surplus.
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
least q_VI = (a-c)/2.
q_VI Again, if U has all the bargaining power, it
will choose w = p_VI, and U will then also
appropriate all of the profit.
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.
Let w = c, retailer would behave as if it were vertically
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
solution would again be
solution p_VI = (a+c)/2 and q_VI = (a-c)/2
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
would outbid each other until F absorbs all
profits manufacturers profits as if it owned
the retailer (= vertical chain)
17 If uncertainty is present… Non-linear pricing makes retailer react to demand or cost
shocks in the same way as vertically integrated firm
shocks Retailer would be at high risk, a his profits are not protected
In order to insure him, manufacturer has to guarantee a certain
minimum Resale Price Maintenance gives perfect insurance under
demand uncertainty, but is bad under cost uncertainty,
as shock in w will greatly affect profits of retailer.
RPM better under demand uncertainty, non-linear pricing...
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- Spring '13