Third-Degree Price Discrimination With Interdependent Demands

This paper analyzes the price, output, and welfare effects of third-degree price discrimination for a monopolist who sells in two interdependent markets. The case where the two goods sold by the monopolist are complements is analyzed as well as the more typical case where the two goods are substitutes. The economic effects of price discrimination are shown to depend on the type and strength of demand interdependence, the curvature of the demands and the slope of marginal cost. The circumstances under which price discrimination causes both market prices to either rise or fall are also analyzed.     

Vertical Contracts and Downstream Entry*

We study the implications of different contractual forms in a market with an incumbent upstream monopolist and free downstream entry. We show that traditional conclusions regarding the desirability of linear contracts radically change when entry in the downstream market is endogenous rather than exogenous. By triggering more entry than two-part tariffs, wholesale price contracts can generate higher aggregate output, consumer surplus, and welfare. In light of this, the upstream monopolist may prefer to trade with wholesale price contracts as well as to give up part of its bargaining power when it is high.     

Bundling, Competition and Quality Investment: A Welfare Analysis

We investigate how bundling affects investment in product quality, and derive welfare implications. A monopolist in a primary market competes with a rival in a complementary market. Bundling is the monopolist’s preferred strategy, since it either extracts surplus from the rival’s investment, or forces the rival to provide low quality. Bundling may reduce welfare without foreclosing the rival, but improves welfare when preventing undesirable investment. Since prohibiting bundling is not appropriate, we introduce a price test for bundled offers that preserves efficiencies from both bundling and quality investment, thereby improving welfare relative to the ‘do-nothing’ scenario. We consequently argue that this test should be applied whenever possible.     

An antitrust analysis of bundled loyalty discounts

Consider a monopolist in one market that faces competition in a second market. Bundled loyalty discounts, in which customers receive a price break on the monopoly good in exchange for making all purchases from the monopolist, have ambiguous welfare effects. Such discounts should not always be treated as a form of predatory pricing. In some settings, they act as tie-in sales. Existing tests for whether such discounts violate competition laws do not track changes in consumer surplus or total surplus. We apply a new test to an illustrative example based on SmithKline that assumes the “tied” market has homogeneous goods. If the tied market is characterized by Hotelling competition, bundling by the monopolist causes the rival firm to reduce its price. In numerical examples, we find that this can deter entry or induce exit.     

Welfare Changes in the Cournot Setting with an Empirical Application to the Telecommunications Industry

I characterize the efficiency of the Cournot equilibrium and provide bounds for the loss in consumer surplus, producer surplus and welfare when the number of firms in the market changes. I only assume that demand is decreasing in price and costs increasing in the quantity produced as long as equilibrium exists. I show how price, demand and average cost, before and after the number of firms in the market changes, can be used to compute these bounds. I apply these bounds to the Portuguese wireline market and conclude that welfare increased significantly when the monopolist was split in 2007.     

Informative Advertising and Optimal Targeting in a Monopoly

This paper analyzes how the transition from mass to specialized advertising can affect the market outcomes. To that end, we consider a particular technology of information transmission which allows a monopolist to decide the optimal targeting strategy. From this starting point, we show that the use of targeted advertising is likely to increase the market price and reduce the level of advertising, and that the degree of media specialization chosen by the monopolist tends to exceed the socially optimal. Furthermore, our model indicates that the social loss resulting from the greater monopoly power might exceed the gain due to the lower wasting of ads, in such a way that targeting could reduce consumer surplus and, what is more important, the level of social welfare.     

The Welfare Losses From Price-Matching PolicIes

Several recent papers argue that price-matching policies raise equilibrium prices. We add to this literature by considering potential welfare losses, which have two sources: Harberger triangles from high prices and Posner rectangles from over-entry. We compare price-matching markets with entry to monopoly and price-matching markets without entry, and find that price matching with entry creates greater welfare losses than monopoly in markets with a low ratio of fixed to marginal cost. We illustrate this result using parameters from the US wholesale gasoline and air travel markets, and relate our model to price matching among NASDAQ market makers.     

Product innovation with vertical differentiation: Is a monopolist's incentive weaker?

This paper compares the incentives for product innovation across different market structures when the new product is vertically differentiated and of lower quality, a common case empirically. We show that innovation incentive rankings across market structures can differ substantially when the new product is of lower rather than higher quality. In particular, the incentive to add the new product can be greater for a monopolist over the old product than for a firm that would face any degree of competition from the old product. This incentive ranking cannot occur when, instead, the new product is of higher quality as has been analyzed in previous work. Moreover, in that case, the incentive ranking is the same whether the market is covered or not covered, whereas in our setting the ranking can differ. With the market covered, our setting provides another environment where the monopolist can have the greatest incentive to innovate, as previously shown when the new product is horizontally differentiated. Together, both settings show that Arrow's famous result—a secure monopolist gains less from a nondrastic process innovation than would a competitive firm—does not always extend to nondrastic product innovations. However, in all the cases analyzed here, consumer welfare (though not total welfare) is always lower under monopoly, even when only the monopolist would add the new product.     

Differential Pricing in Intermediate Good Markets

This paper studies differential pricing by an upstream monopolist whose cost to supply the intermediate good differs across buyers in the downstream. It is shown that, different from demand‐based price discrimination, cost‐based differential pricing shifts production efficiently. If total output (and consumer welfare) is weakly increased under differential pricing as opposed to uniform pricing, as is true for weakly convex final market demand functions, social welfare is strictly improved. The analysis is extended to the case in which both the upstream monopolist's cost to serve the downstream firms and the downstream firms’ cost to produce the final good differ.     

Successive Oligopolies with Differentiated Firms and Endogeneous Entry

We develop a model of successive oligopolies with endogenous entry, allowing for varying degrees of product differentiation and entry costs in both markets. We show that downstream conditions dominate the overall profitability of the two‐tier structure while upstream conditions mainly affect the distribution of profits. We analyze how two‐part tariffs and resale price maintenance shape the endogenous market structure and study their welfare effects. In contrast to previous literature, we find that welfare under linear prices can be larger than under twopart tariffs although the latter avoids double marginalization. This is because linear prices induce more downstream market entry.     

Intertemporal Price Discrimination in Frictionless Durable Goods Monopolies

I show that small differences in quality and production costs between durables and non-durables in a product line allow a durable goods monopolist to intertemporally price discriminate even with continuous trading. In particular, a monopolist would want to both sell and rent out a durable to achieve price discrimination. This incentive to price discriminate simultaneously creates inefficient delay in the sale of the durable good, a finite trading period and long run efficiency of the market. The Coase conjecture fails because the non-durable good acts as an outside option that guarantees a minimum profit in the market for durables.     

Pricing strategy, quality signaling, and entry deterrence

I investigate a pricing strategy that is aimed at deterring entry by applying a two-period model of a durable-goods monopolist. There exists an incumbent that is of two types, that is, high and low quality types. They differ in terms of their R&D capabilities, and the incumbent's type is assumed to be unknown to an entrant. If the entrant decided to enter the market, Nash–Bertrand price competition ensues between the incumbent and the entrant. I show that not only limit pricing but also prestige pricing signals the incumbent's quality type, which serves to discourage entry. In the prestige pricing, the high-quality type sells the products at an intentionally higher price. I also show that although limit pricing is more desirable than prestige pricing from a social welfare viewpoint, the incumbent can still choose prestige pricing.     

Tight Average Revenue Regulation Can Be Worse Than No Regulation

Price regulation of a multi-market monopolist, with the cap based on average revenue, can cause welfare to be below the unregulated level. In a model with linear demands and constant but unequal marginal costs, a sufficient condition for this welfare effect is that the cap equals the average revenue that would be earned with marginal cost pricing. Relaxation of the price cap can lower all prices. Welfare with uniform pricing at the level of the price cap can be above or below the average revenue welfare level.     

CUSTOMER POACHING AND ADVERTISING*

This paper is a first look at the dynamic effects of customer poaching in homogeneous product markets, where firms need to invest in advertising to generate awareness. When a firm is able to recognize customers with different purchasing histories, it may send them targeted advertisements with different prices. It is shown that only the firm which advertises the highest price in the first period will engage in price discrimination, a practice that clearly benefits the discriminating firm. This poaching gives rise to ‘the race for discrimination effect,’ through which price discrimination may act actually to soften price competition rather than intensify it. As a result, all firms may become better off, even when only one of them can engage in price discrimination. This paper offers a first attempt to evaluate the effects of price discrimination on the efficiency properties of advertising. In markets with low or no advertising costs, allowing firms to price discriminate leads them to provide too little advertising, which is not good for consumers and overall welfare. Only in markets with high advertising costs, might firms overadvertise. Regarding the welfare effects, price discrimination is generally bad for welfare and consumer surplus, though good for firms.     

Multilateral Vertical Contracting with an Alternative Supply: The Welfare Effects of a Ban on Price Discrimination

Rey and Tirole [Handbook of Industrial Organization. Amsterdam: Elsevier (2005)] considered a model in which a monopolist sells to downstream firms using nonlinear contracts. They showed that banning price discrimination fully restores the supplier’s ability to leverage its monopoly power by enabling it to commit not to offer side discounts. I show that the situation changes when the supplier competes against a fringe of less efficient rivals rather than being a monopolist. Then banning price discrimination may cause per-unit prices to fall and welfare to increase. The dominant supplier can take advantage of a strategic bargaining effect: reducing the per-unit price makes the outside option of buying from the fringe less profitable, allowing the dominant supplier to extract more bargaining surplus through the fixed fee.     

INPUT PRICE DISCRIMINATION WHEN BUYERS OPERATE IN MULTIPLE MARKETS*

This paper revisits third‐degree price discrimination when input buyers serve multiple product markets. Such circumstances are prevalent since buyers often use the same input to produce different outputs, and even homogenous outputs are routinely sold through different locations. The typical view is that price discrimination stifles efficiency (and welfare) by resulting in price concessions to less efficient firms. When buyers serve multiple markets, price discrimination leads to price breaks for firms in markets with lower demand. When lower demand markets also have less competition, price discrimination can provide welfare gains by shifting output to less competitive markets.     

OPTIMAL PRICING AND QUALITY CHOICE WHEN INVESTMENT IN QUALITY IS IRREVERSIBLE

This paper examines the price and quality choice of a single product, risk-neutral monopolist who can delay irreversible investments required for market entry. It is shown that the price and quality she chooses at entry increase with uncertainty about the size of future demand. In a Stackelberg leader-follower game, the leader and follower pre-commit immediately up to a certain level of uncertainty. In this case the leader produces the higher quality good. When uncertainty is higher than this threshold, the follower will wait and enter the market later with a higher quality good.     

Estimation of the Effects of New Brands on Incumbents’ Profits and Consumer Welfare: The U.S. Processed Cheese Market Case

I estimate the effects of new brands on market competition and consumer welfare in the U.S. processed cheese market. I find that an observed increase in consumer welfare was attributable mainly to an increase in the number of brands in the sample market, while the price effect, which measures welfare change caused by adding new brands to existing brands, decreased welfare as the prices of the existing brands increased in a large portion of sample markets. The price increase was most pronounced among the introducers existing brands. I also find that the data used in the paper identify a significant enhancement of consumer welfare as a result of the change in product characteristics provided by new brands even if a large portion of welfare gain is explained by the assumption on the error term in the utility function.JEL classification: D40, D60, L13, L66, H20     

Taxation and Durable Goods Monopoly*

This paper studies the role of taxation in durable good markets with dynamic monopolies. By conditioning the marginal tax rate on the volume of trade, the regulator can provide incentives for the monopolist to accelerate trade. When marginal cost pricing generates a loss for the monopolist, strategic delay cannot be avoided under regulatory budget constraint and the effects of tax policy depend on the monopolist's ability to commit. In the context of binary consumer types, we find a tax policy involving “back-loaded subsidy” that achieves the second-best outcome with commitment. In contrast, without commitment, a “front-loaded subsidy” improves welfare.     

Wholesale market definition in telecommunications: The issue of wholesale broadband access

The scope of a wholesale market may, in addition to demand- and supply-side substitution at the wholesale level, also be determined by substitution patterns at the retail level. Considering wholesale broadband access markets, it is argued that each of these forces can be strong enough to render a 5–10% price increase by a hypothetical monopolist at the wholesale level unprofitable and thus may lead to a wider wholesale market definition including, for example, cable networks in addition to DSL. Based on the theory of derived demand elasticities the paper discusses under which circumstances this could be the case. The position of the European Commission and the practice of national regulatory authorities are then reviewed in light of these arguments.