Vertically related markets

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Questions and Answers

What is one of the primary benefits of vertical mergers?

Increased competition among retailers

Higher retail prices for consumers

Elimination of double-marginalization (correct)

Decreased efficiency in production

What does the moral hazard problem refer to in the context of retail services?

Manufacturers being unable to observe retailers' service efforts (correct)

Increased competition leading to reduced service levels

Retailers charging consumers too much for services

Consumers not valuing retail services enough

In the context of linear pricing, what issue can arise that affects service provision?

Manufacturers reduce product prices significantly

The retailer prioritizes sales over customer service

Consumers demand higher prices for services rendered

The retailer does not consider the impact of service on manufacturer profits (correct)

What is a potential negative effect of input foreclosure in vertical mergers?

Higher input prices for competitors Signup and view all the answers

How does a vertically integrated firm affect markets following a merger?

It may restrict supply to increase input prices Signup and view all the answers

Why do retailers often provide complementary services?

To increase consumer willingness-to-pay Signup and view all the answers

What can be a consequence of the double-marginalization problem?

Inefficient pricing and service strategies Signup and view all the answers

What is the likely outcome of customer foreclosure in vertical mergers?

Reduced access for competitors to a critical customer base Signup and view all the answers

What is a primary contractual solution for managing intrabrand competition?

Exclusive territories. Signup and view all the answers

How does exclusive dealing relate to competition practices?

It prevents retailers from selling competing products. Signup and view all the answers

Which issue can arise due to double marginalization in retailing?

High prices from the retailer due to supplier contracts. Signup and view all the answers

What does a tie-in sale contract allow manufacturers to do?

Force retailers to purchase necessary inputs exclusively from them. Signup and view all the answers

What is a potential consequence of exclusive territories for retailers?

Limited customer base due to geographical restrictions. Signup and view all the answers

What is a key characteristic of double marginalization in successive monopolies?

Two separate margins are added to the price, increasing overall retail prices. Signup and view all the answers

Which of the following contractual solutions can help achieve the monopoly price related to vertical integration?

Ensuring the final price reflects the true cost of production. Signup and view all the answers

How does vertical integration impact retail pricing compared to a system of double marginalization?

Retail prices are always lower with vertical integration. Signup and view all the answers

What happens to the inefficiencies caused by double marginalization when market power is reduced at one supply chain level?

Inefficiencies decrease, making pricing more efficient. Signup and view all the answers

Study Notes

Retail Services

Retailers often provide services beyond selling products.
Examples include explaining product functionalities, and managing staffing to maintain short lines.
This can increase consumer willingness to pay.
There is a moral hazard problem; manufacturers want to compensate retailers for providing services but cannot easily observe their efforts.
A model can be used to represent this:
- Market demand depends on retail price and service level.
- Retailers incur a cost per unit of output based on service level.
- Vertically integrated structures maximize profit by selecting the optimal retail price and service level.

Linear Wholesale Pricing

Manufacturers set a wholesale price to maximize profit.
Retailers then choose retail prices and service levels to maximize their profit.
This often results in a double-marginalization problem.
Retailers may under-provide services because they don't fully consider their impact on the manufacturer’s profit.

Vertical Mergers

Positive Welfare Effects
- Eliminates double-marginalization, increasing consumer surplus and profits for merging firms.
Potential Negative Welfare Effects
- Input Foreclosure: The vertically integrated firm may restrict or stop the supply of inputs to competitors, potentially raising input prices.
- Customer Foreclosure: The vertically integrated firm may limit access or restrict upstream competitors’ ability to reach customers, harming competition.

Successive Monopolies

Assumptions:
- Demand is linear and depends on the retail price.
- One manufacturer with a marginal cost of production.
- One retailer with no costs other than the unit price paid to the manufacturer.
- The manufacturer sets the wholesale price first, followed by the retailer setting the final price.
Analysis compares outcomes under vertical integration and separate entities.

Double Marginalization

Subgame-perfect Equilibrium: Each firm sets its price to maximize profit, taking the other firm’s behavior as given.
Vertical Integration: Manufacturers and retailers merge, allowing them to set the final price for maximum profit as a single entity.
Intuition: Retail prices are higher under separate entities in a vertical supply chain than under vertical integration because retailers do not consider the full effect of their pricing decisions on the manufacturer’s profit.

Double Marginalization: Insights

Pricing Inefficiency: Retail prices are higher due to the "double-marginalization" of adding margins at both the manufacturer and retailer levels.
Externalities: Retailers do not consider the effect of their pricing decisions on the upstream manufacturer's profit.
Extensions:
- The problem intensifies in successive monopolies where each firm sets a monopoly price.
- Double-marginalization becomes less pronounced as market power decreases in one layer of the supply chain under imperfect competition.

Contractual Solutions: Vertical Restraints

Objective: Contractual arrangements aim to replicate the monopoly solution of a vertically integrated firm while maintaining separate entities.
Key: Final prices rely on the true cost of production, not the wholesale price, to achieve the monopoly outcome.
Intrabrand Competition: Competition among retailers selling the same brand.
- Exclusive Territories: Assigning specific geographic areas or customer types to retailers can help prevent price competition.
Multiple Manufacturers/Inputs:
- Tie-in: A manufacturer might require a retailer to purchase another input from them.
Multiple Final Goods/Interbrand Competition:
- Exclusive Dealing: A manufacturer might prevent a retailer from selling competing products.

Example of Exclusive Dealing

Preventing a retailer from selling competing products can be considered anticompetitive.

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Description

Explore the dynamics of retail services and linear wholesale pricing through this quiz. Understand the implications of service levels on pricing strategies and the challenge of double-marginalization. Delve into how retailers and manufacturers interact to maximize profits within these frameworks.