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Double Marginalization. A Classroom Experiment. Overview. Bad Economist Joke: Q: What’s worse than one monopolist? A: Two monopolists How does monopoly power work in vertical markets? What is the double marginalization problem? How can we fix the double marginalization problem?.

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double marginalization

Double Marginalization

A Classroom Experiment

overview
Overview
  • Bad Economist Joke:
    • Q: What’s worse than one monopolist?
    • A: Two monopolists
  • How does monopoly power work in vertical markets?
  • What is the double marginalization problem?
  • How can we fix the double marginalization problem?
key lessons part 1
Key Lessons: Part 1
  • Profit Maximizing Pricing
    • Monopoly pricing
    • Look forward, reason back (for upstream firm)
key lessons part 2
Key Lessons: Part 2
  • Integration:
    • How much value is created by integrating?
    • Who captures this value?
  • Contracting:
    • How much value is created through franchise fees?
    • Now who captures this value?
double marginalization5
Double Marginalization
  • Consider two independent firms, upstream and downstream, that each have market power
  • Each firm then prices at a mark-up over marginal cost.
  • Recall that pricing above MC yields deadweight losses
  • Now these are being incurred twice!
double marginalization6
Double Marginalization
  • If upstream and downstream merge, then upstream ceases to try to capture surplus from downstream.
  • Upstream prices (transfers) at MC.
  • One deadweight loss eliminated.
  • Like picking money up off the table!
double marginalization experiment analysis
Double Marginalization Experiment Analysis

Retail

Price

Retail Demand

12

Quantity

12

double marginalization problem
Double Marginalization Problem

Retail

Price

12

Marginal Revenue

Quantity

12

double marginalization problem9
Double Marginalization Problem

Retail

Price

12

4

Marginal Cost

Quantity

QC = 8

12

double marginalization problem10
Double Marginalization Problem

Retail

Price

12

Marginal Cost

Quantity

QC

QC = 8

12

QM = 4

double marginalization problem11
Double Marginalization Problem

Retail

Price

Wholesale profits

12

Wholesale Price

8

Wholesale

Margin

4

Marginal Cost

Quantity

QC = 8

12

QM = 4

QDM =2

double marginalization problem12
Double Marginalization Problem

Retail

Price

Retail profits

12

10

Retail

Margin

Wholesale Price

8

4

Marginal Cost

Quantity

QC = 8

12

QM = 4

QDM = 2

key point
Key Point
  • Everyone is worse off under double marginalization
  • Firms are worse off in terms of industry profits:
    • Under Double Marginalization
      • 2 units x ($10 - $4) = $12
    • Under Monopoly
      • 4 units x ($8 - $4) = $16
consumers are worse off too
Consumers Are Worse Off Too

Retail

Price

Surplus Under double marginalization

12

Wholesale Price

Marginal Cost

Quantity

QC

12

QDM

QM

consumers are worse off too15
Consumers Are Worse Off Too

Retail

Price

Surplus Under monopoly

12

Wholesale Price

Marginal Cost

Quantity

QC

12

QDM

QM

gm and fisher body
GM and Fisher Body
  • Fisher body had custom machines and dies to produce car bodies for GM
  • GM’s chassis were likewise customized for Fisher’s bodies.
  • There was upstream and downstream market power (double marginalization problem)
  • GM acquires Fisher body
contractual solutions
Contractual Solutions
  • Using “two-part tariffs” can also overcome the double marginalization problem.
  • Recipe for Two-Part Tariffs
  • Part 1: Maximize value created
  • Part 2: Use the fixed fee to capture value
two part tariffs in action
Two-Part Tariffs in Action
  • Part 1: Maximize Value Created
    • The wholesaler can set the wholesale price at marginal cost
    • This maximizes the size of industry profits
  • Part 2: Capture Value
    • It can then use the franchise fee to capture the bulk of this additional value created.
other issues
Other Issues
  • How should competition authorities in government view this type of firm behavior?
  • Are there other contractual forms that might solve this problem?
  • Why might some firms solve the problem by merging while others prefer contracts?
  • Porter forces analysis