Department of Economics, University of Oslo. ECON4820 Spring Last modified:

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1 Department of Economics, University of Oslo ECON4820 Spring 2010 Last modified: Producers s Outline Products are sold through s. How does this affect market performance? Situation: Monopolist sells to one or more s Questions: Whydoesthemonopolistwanttocontrol the behavior of the (s)? Does such vertical control increase or decrease welfare? Questions: Why might the monopolist want to refuse to deal with some (s)? Does such increase or decrease welfare?

2 Do vertical controls & decrease welfare? Outline Chicago school: controls & does not lead to increased monopoly power for the vertical structure; they are only welfare-enhancing Legal status: Many forms of vertical contracts are illegal in different countries. Why? Outline Outline Framework Forms of contracting between manufacturers s Targets, instruments sufficiency Double marginalization Downstream moral hazard Input substitution ( & several s) & (refuse to deal with some s) (several manufacturers )

3 Notation Forms of contracting Terminology p w : Wholesale (intermediate) price p: Consumer (retail, final) price q = D(p): Consumers downward-sloping dem function q = D(p, s): If dem also depends on promotional service s exerted by the Forms of contracting Forms of contracting Terminology Linear price: T (q) =p w q Two-part tariff & franchise fee: T (q) =A + p w q Resale-price maintenance (RPM) (a) Price ceiling (p p) (b) Price floor (p p) Quantity fixing (a) Quantity forcing (q q) (b) Quantity rationing (q q) Tie-in Exclusive territories under intrabr when different s otherwise would have carried the same br Exclusive dealing under interbr when a otherwise would have carried different brs

4 Terminology Forms of contracting Terminology Aggregate profit: The sum of the manufacturer s the s profits Targets: Variables that affect aggregate profit, like the consumer price the promotional service Instruments: Variables that can be specified in a contract between a manufacturer a Sufficiency: Instruments are sufficient if they enable the parties to maximize aggregate profit Double marginalization Moral hazard Input substitution er does not take into account that p w > c Wholesale price > Manufacturer s MC

5 Double marginalization Double marginalization Moral hazard Input substitution Franchise fee Price ceiling Quantity forcing controls enhance welfare Downstream moral hazard Double marginalization Moral hazard Input substitution Franchise fee Quantity forcing controls enhance welfare

6 Input substitution Double marginalization Moral hazard Input substitution Franchise fee Tie-in combined with price ceiling controls enhance welfare We now assume that the downstream sector is competitive : A monopolist has control over the production of a product or service that is an essential input for firms in a potentially competitive industry. The in this industry can be altered by the monopolist by denying or limiting access to the input. The monopolist has control over an essential facility constituting a bottleneck. Examples: In network industries: Access needed to deliver product/service Telecom: AT&T (followed by Baby Bells), Telenor Power: Statnett Shipping: Habors Railway: Eurotunnel Outside network industries: At an disadvantage without access Computer reservation systems for airlines Distribution of goods: retailing chains (food stores, pharmacies, book stores, pubs)

7 First, retail that are useful for consumers that buy from the providing the Resale-price maintenance Exclusive territory combined with a franchise fee controls may enhance or reduce welfare Now, retail that are useful for consumers independently of from which they end up buying Price floor Exclusive territory combined with a franchise fee p w < c controls enhance welfare

8 Having contracted with one downstream firm, the upstream firm has incentives to contract further with other downstream firms, even though these firms in turn will compete with the first firm decrease its profit The first downstream firm realizes this is less willing to sign a contract. This reduces the upstream firm s profit The upstream firm will be looking for ways to get around this problem Analog: The durable-good monopolist ( Coase conjecture ) Competition between s facilitates the provision of incentives (from the manufacturer to the s) controls may lead to cartelization of the s

9 May exclusive dealing lead to enhanced promotional efforts from the manufacturer, since with exclusive dealing other manufacturers will not share the benefits? May exclusive dealing lead to increased barriers to entry decreased between manufacturers? Competition policy should be governed by rule of reason It is hard to distinguish between welfare enhancing welfare reducing vertical controls