Chapter 13

Question 1

Reasons why the relationship between a manufacturer and a retailer is different from a direct relationship between firm and final consumer

Answer 1

1. Demand faced by a manufacturer depends on the price it set and on a host of other factors, which it mostly does not directly control.
2. Retailers compete with each other whereas consumers do not.
3. A firm selling to a retailer has less market power than if it sells to a consumer

Question 2

Vertical integration profits

Answer 2

If a manufacturer sets a wholesale price to a vertically separated retailer, then their joint profits are lower, and retail price is higher, than under vertical separation. –> double marginalization problem

Question 3

Double marginalization problem

Answer 3

Combined profits of M and R are lower than if they were integrated

Question 4

Downstream competition with vertical integration

Answer 4

We expect the profits of the integrated firm to increase, and the other downstream firm to decrease.

Customers: getting rid of the double marginalization problem is good, but softening downstream competition is bad; effect is ambiguous

Question 5

Investment incentives & vertical integration

Answer 5

When investments in specific assets are at stake, vertical integration alleviates the hold-up problem but increases the agency problem

Question 6

Vertical restraints - nonlinear pricing

Answer 6

Consist of a two-part tariff (f,w)

If non-linear contracts are possible, then the optimal solution under vertical separation is identical to that under vertical integration.

Allowing for fixed fees, the upstream firm’s profit maximization problem is essentially equivalent to maximizing joint profits of the upstream and downstream firms, and then finding the maximum fee the downstream is willing to pay

Question 7

Slotting allowances

Answer 7

Fees paid by manufacturers to obtain retail patronage

Question 8

Resale price maintenance

Answer 8

Many price-conscious consumers will visit the first retailer to learn about the available products; and then visit the second retailer to purchase the preferred product at a low price.

Externality: the investment in sales effort by the first retailer benefits both retailers –> free rides

RPM provides a solution to the above situation: the practice whereby the manufacturer imposes a minimum price on retailers

Question 9

Exclusive territories and exclusive dealing

Answer 9

Vertical restraints such as resale price maintenance, exclusive territories, and exclusive dealing allow upstream and downstream firms to internalize the effects of demand-increasing investments.