Pricing Access to a Monopoly Input

What price should downstream entrants pay a vertically integrated incumbent monopoly for use of its assets? Courts, legislators, and regulators have at times mandated that incumbent monopolies lease assets required for the production of a retail service to entrants in efforts to increase the competitiveness of retail markets. This paper compares two rules for pricing such monopoly inputs: marginal cost pricing (MCP) and generalized efficient component pricing rule (GECPR). The GECPR is not a fixed price, but is a rule that determines the input price to be paid by the entrant from the entrant's retail price. Comparing the retail market equilibrium under MCP and GECPR, the GECPR leads to lower equilibrium retail prices. If the incumbent is less efficient than the entrant, the GECPR also leads to lower production costs than does the MCP rule. If the incumbent is more efficient than the entrant, however, conditions may exist in which MCP leads to lower production costs than does the GECPR. The analysis is carried out assuming either Bertrand competition, quantity competition, or monopolistic competition between the incumbent and entrant in the downstream market.     

Incentive effects of paying demand response in wholesale electricity markets

Recently issued U.S. Federal Energy Regulatory Commission regulations require comparable treatment of demand reduction and generation in the wholesale electric market so that they are compensated at the same market clearing price. The new regulations measure demand reduction as a reduction from a “customer baseline,” a historically based estimate of the expected consumption. In this paper, we study the incentive effects on the efficiency of the demand response regulation using a static equilibrium model and a dynamic extension of the model. Our analysis provides three main results. Firstly, our analysis shows that the demand reduction payment will induce consumers to (1) inflate the customer baseline by increasing consumption above the already excessive level during normal peak periods and (2) exaggerate demand reduction by decreasing consumption beyond the efficient level during a demand response event. This result persists when applied to alternative baseline designs in a dynamic model. Secondly, we study alternative policy remedies to restore the efficiency of demand response regulation and introduce a new approach to define the customer baseline as a fixed proportion of an aggregate baseline. In particular, the aggregate baseline approach can significantly weaken or eliminate the incentive to inflate the baseline. Finally, we illustrate that if the baseline inflation problem is solved and demand and supply functions are linear, the current policy can produce a net social welfare gain. However, the welfare improvement requires that demand reduction be paid only when the wholesale price is at least twice the fixed retail rate. This argues that the policy should include a sufficiently high threshold price below which demand response is not dispatched.     

Trade Policies for Exporting Industries under Free Entry

This paper computes optimal export taxes and domestic production subsidies for exporting industries under free entry. We show that domestic welfare is not at maximum, as is typically believed, when the export price is a monopoly price, and the domestic price is a competitive price, because a market structure effect has to be taken into account. Furthermore, we show that the optimal tax/subsidy formulas for an oligopoly coincide with those under perfect competition, if foreign and domestic demand functions are both linear. We also discuss optimal trade policies when only one instrument is available, and we run numerical simulations to determine and compare optimal trade taxes under endogenous and exogenous market structures.     

Third‐degree price discrimination in the presence of congestion externality

This paper analyzes third‐degree price discrimination of a monopoly airline in the presence of congestion externality when all markets are served. The model features the business‐passenger and leisure‐passenger markets where business passengers exhibit a higher time valuation, and a less price‐elastic demand, than leisure passengers. Our main result is the identification of the time‐valuation effect of price discrimination, which can work in the opposite direction as the well‐known output effect on welfare. This time‐valuation effect clearly explains why discriminating prices can improve welfare even when this is associated with a reduction in aggregate output.     

IMPERFECT SUBSTITUTES FOR PERFECT COMPLEMENTS: SOLVING THE ANTICOMMONS PROBLEM

An integrated monopoly, where two complements forming a composite good are offered by a single firm, is typically welfare superior to a complementary monopoly. This is ‘the tragedy of the anticommons’. We analyse the robustness of such result when competition is introduced for one or both complements. Particularly, competition in only one of the two markets may be welfare superior to an integrated monopoly if and only if the substitutes differ in their quality so that, as their number increases, average quality and/or quality variance increases. Then, absent an adequate level of product differentiation, favouring competition in some sectors while leaving monopolies in others may be detrimental for consumers and producers alike. Instead, competition in both markets may be welfare superior if goods are close substitutes and their number in each market is sufficiently high, no matter the degree of product differentiation.     

Complementarity of willingness to pay and cost heterogeneity under vertical product differentiation: A welfare analysis

Due to the fact that a consumer’s willingness to pay differs between segments, many unregulated industries are price constrained, although the specific costs of market segments also differ. If the product quality is endogenously chosen, we find that third-degree price discrimination increases welfare if a sufficiently pronounced complementarity between the willingness to pay and variable cost heterogeneity is given. This is due to the fact that the monopolist’s incentive for employing a pronounced price dispersion strategy is directly influenced by the consumers’ willingness to pay for the quality of a product. With endogenous product quality, the paper shows that the standard welfare result of third-degree price discrimination compared to uniform monopoly pricing (e.g. that total welfare and consumer surplus both fall if total output does not rise) can be only reversed given the complementarity is sufficiently pronounced.     

Utility Regulation and Risk Allocation: The Roles of Marginal Cost Pricing and Futures Markets

The effects on consumer welfare of requiring a utility facing cost or demand risk to use either a fixed retail price or marginal cost pricing are assessed. With marginal cost pricing and cost volatility an efficient futures market allows consumer welfare to be at least as high in every state as with the fixed price. With demand risk marginal cost pricing can benefit the consumer in every state without harming the firm if the profit difference is transferred to the consumer. A futures market can act as a partial replacement for the transfer.     

ENTRY REGULATIONS,WELFARE, AND DETERMINANTS OF MARKET STRUCTURE

Welfare effects of entry regulations are theoretically ambiguous in differentiated product markets. We use a dynamic oligopoly model of entry and exit with store‐type differentiation and static price setting to evaluate how entry regulations affect long‐run profitability, market structure, and welfare. Based on unique data for all retail food stores in Sweden, we estimate demand, recover variable profits, and estimate entry costs and fixed costs by store type. Counterfactual policy experiments show that welfare increases when competition is enhanced by lower entry costs. Protecting small stores by imposing licensing fees on large stores is not welfare enhancing.     

RETAIL PRICE REGULATION AND THE OPTION TO DELAY

ABSTRACT ** :  This paper examines a two-period model of an investment decision in a network industry characterized by demand uncertainty, economies of scale and sunk costs. In the absence of regulation we identify the market conditions under which a monopolist decides to invest early as well as the underlying overall welfare output. In a regulated environment, we consider a monopolist who faces no downstream (final good) competition but is subject to retail price regulation. We identify the welfare-maximizing regulated prices when the unregulated market outcome is set as the benchmark. We show that if the regulator can commit to ex post regulation – that is, regulated prices that are contingent to future demand realization – then regulated prices that allow the firm to recover its total costs of production are welfare-maximizing. Thus, under ex post price regulation there is no need to compensate the regulated firm for the option to delay that it foregoes when investing today. We argue, however, that regulators cannot make this type of commitment and, therefore, price regulation is often ex ante – that is, regulated prices are not contingent to future demand. We show that the optimal ex ante regulation, and the extent to which regulated prices need to incorporate an option to delay, depend on the nature of demand uncertainty.     

ON THE PROFITABILITY OF RESALE PRICE MAINTENANCE WHEN DEMAND IS UNCERTAIN

A previous study finds that in a market where a manufacturer faces uncertain demand and sells to consumers through competitive retailers, the manufacture wishes to support adequate retail inventories by imposing resale price maintenance (RPM). I show that if retail inventories are allocated to consumers through first‐come‐first‐served rule rather than efficient rationing rule in the game with unconstrained retail competition, imposing RPM may not be profitable. It may not encourage more retail inventories either. RPM may also lower consumer surpluses and social welfare. This study casts some doubt on the demand uncertainty theory that supports RPM.     

Corporate social responsibility and marketing channel coordination

We analyze a simple linear demand bilateral monopoly situation where one of the firms, either the up-stream manufacturer or the down-stream retailer, is socially concerned in terms of its desire to enhance its end-customers’ welfare in addition to the traditional profit motive. Two cases are explored: the up-stream producer exhibits corporate social responsibility (CSR) in one case and the down-stream retailer in the other. In the two-stage game, the retailer makes their quantity-setting decision in stage-two, given the two-part tariff (wholesale price and fixed franchise fee) set by the stage-one producer. In this setting, among other things, we find that the optimal channel-coordinating tariff is very different from the standard pure profit-maximizing two-part tariff. For example, if either firm in the supply/marketing chain exhibits CSR, we show the optimal wholesale price does not equal the manufacturer’s marginal production cost, nor does the fixed fee equal the monopoly profit earned by the retailer. Finally, we find that our two-part tariff CSR model provides a theoretical rationale for the empirical finding of little to no correlation between CSR and firm profits.     

Industry equilibrium under random demand

The paper deals with the characterization of long-run industry equilibrium under random demand, for the two polar cases of perfect competition and pure monopoly. Contrary to the basic theorem of welfare economics for the standard (deterministic) case, it is shown that perfect competition does not in general lead to an optimal (efficient) outcome. Perfect competition is optimal if and only if firms display risk-neutrality with respect to profits. Surprisingly enough, when risk preferences are non-neutral, one could by means of price regulation lead monopoly to behave optimally, whereas this is impossible for competition.     

RETURNS SYSTEM WITH REBATES*

We consider a variant of the newsvendor problem. Atomistic retailers each buy merchandise from a monopoly supplier for resale at a market‐determined common retail price that depends upon the total industry order quantity and upon a stochastic demand. After the orders are filled, the supplier learns the realization of demand but the retailers do not. We show that, in this setting, a returns system with rebates (with previously set buy‐back price for returns and ex post payments from the supplier to each retailer per unit actually sold) implements the optimal production and sales strategy, attaining maximum expected profit in the channel.     

Third-degree price discrimination,quality choice,and welfare

Employing an endogenous quality choice model, we reconsider the effect on welfare of monopolistic third-degree price discrimination. We prove that price discrimination always enhances welfare, mainly because the quality improvement owing to price discrimination increases consumer surplus. Moreover, we show that third-degree price discrimination benefits all parties, including consumers in the higher priced market if the preference differences between markets are sufficiently large.     

Strategic competition and optimal parallel import policy

Abstract In a two‐country Hotelling type duopoly model of price competition, we show that parallel import (PI) policy can act as an instrument of strategic trade policy. The home firm’s profit is higher when it cannot price discriminate internationally if and only if the foreign market is sufficiently bigger than the domestic one. The key mechanism in the model is that the home firm’s incentive to keep its domestic price close to the optimal monopoly price affects its behavior during price competition abroad. We also analyze the welfare implications of PI policies and show that our key insights extend to quantity competition.     

A test of monopoly price dispersion under demand uncertainty

A test of the predictions of Dana’s (2001) model of monopoly price dispersion under demand uncertainty using ticket price data from Major League Baseball shows that ticket price dispersion changes systematically with demand uncertainty, verifying the predictions of the model.     

State monopolies and alcoholic beverage consumption

Fifteen states have state monopolies to regulate the retail distribution of distilled spirits or wine. One objective of state ownership is the reduction of consumption. However, previous research supports both no effect and a negative effect of state monopoly (control) states on consumption.Using improved data on prices, this paper provides a mixture of classical and Bayesian estimates of beverage-specific demand functions. The analysis is carried out at the state level for the year 1982. Independent variables include the real own-price, substitute prices, income, tourism activity, religious sentiment, youth proxy, and several regulatory measures including monopoly control, bans on price advertising, minimum legal drinking age, and restrictions on the number and type of retail outlets.The results indicate no direct effect of monopoly control on consumption that is separate from effects manifested by higher prices or, for beer, limited outlets. Furthermore, average prices are not significantly greater in the monopoly states. Several possible explanations are advanced to explain these results, including the likelihood that the higher transaction costs in the monopoly states are a tax on consumption of alcohol.     

内生无效制度——对进入壁垒和贸易保护的思考

本文构建一个模型来考察为什么垄断、进入壁垒和贸易保护在许多国家长期存在。政治精英对中间产品索取高价的偏好导致了支持垄断和贸易保护的无效经济制度和政治制度。价格操纵机制表明,政治精英偏好于通过提高中间产品价格来增加垄断利润。提高税率虽然会增加政治精英的税收收入,但会降低对中间产品的需求,从而减少垄断利润。因此,价格操纵情况下的最优税率低于收入摄取情况下的最优税率,这与Acemoglu(2006)的结论相反。     

最优专利制度研究

本文构建了一个动态一般均衡模型来研究最优专利长度和最优专利宽度的问题。研究结论表明,最优的专利长度和专利宽度都是有限的。专利长度的增加会通过促进创新来提高社会福利水平,同时,也会导致市场扭曲,从而降低社会福利水平,但随着专利长度的不断增加,前者的效应会小于后者的效应,因此,有限的专利长度是最优的。有效的专利宽度应该一方面使得模仿产品的质量水平不要太低,从而保证模仿产品对专利产品形成潜在的威胁,逼迫专利产品的价格低于垄断价格,减小市场扭曲;另一方面使得模仿产品的质量不要太高,从而保证专利产品能够制定较高的垄断价格,促进创新。     

Foreign market entry,upstream market power,and endogenous mode of downstream competition

In a differentiated duopoly model of trade and FDI featuring both horizontal and vertical product differentiation, we examine whether globalization and trade policy measures can generate welfare gains by leading firms to change their mode of competition. We show that when a high-quality foreign variety is manufactured under large frictions due to upstream monopoly power, a foreign firm can become a Bertrand competitor against a Cournot local rival in equilibrium, especially when the relative product quality of the foreign variety is sufficiently high and trade costs are sufficiently low (implying higher input price distortions due to double marginalization). Our results suggest that such strategic asymmetry is welfare improving and that the availability of FDI as an alternative to trade can make welfare-enhancing strategic asymmetry even more likely, especially when both input trade costs and fixed investment costs are sufficiently low and trade costs in final goods are sufficiently large.