Vertical Restraints in New Cars Market Flashcards
Define the Market
What were the regulations involved?
Note:
Article 81 is now Article 101 in Europe or Chapter 1 in UK
Article 81(1) prohibits agreements, Article 81(3) gave some exemptions to this
Firms must notify the commission of agreements in advance to get exemptions
European Commission gave block exemptions because they believed efficiencies in agreements outweighed downsides
- There were also market share thresholds within these exemptions to stop already powerful firms from gaining the benefits (introduced in 2002) (Value was around 30-40%)
- Black Clauses were never allowed, regardless of market shares
Exclusive Distribution can remove Intrabrand competition
Exclusive Dealing removes Interbrand competition
The market was very unregulated in 1985
After 2002 reforms, most manufacturers opted for selective distribution
Stricter rules on Exclusive Dealing meant dealerships could sell up to 3 brands
What is the retailer free rider problem?
Retailers won’t invest because if they do then another retailer may just benefit from the service the first provides, without having the increased cost (so giving a cheaper product)
Examples may include investing in staff so they give good info and increase the WTP of customers
Another example may be a dealer investing in their showroom meaning the buyer receives a higher quality experience of purchase
Last example may be investment in advertising
The Manufacturer will prefer q’(w) [the [position where the dealer has invested in services] and so will want to incentivise this
Retailers have no incentive to invest in advertising because at q(w) or q’(w) their profits are still 0
The argument is that no investment in services will leave lower total welfare than when there is investment
- The original welfare is triangle w,p,D (red area); the second one is a kite shape w,p’,D’ (blue area)
Note:
D = MR
This reduces intrabrand competition
What is the manufacturer free rider problem?
The manufacturers will invest in dealers’ services themselves
This causes a problem when there is interbrand competition at the same dealer
The investing manufacturer may not reap all the benefits from investing in the service
This can disincentivise the manufacturers from investing
Exclusive dealing helps this by making a dealer only able to supply from manufacturer 1
What are the downsides from exclusive dealing?
Foreclosure wasn’t seen as a problem before 1985 because the Chicago school had a theory saying it wasn’t a problem
If the dealer agrees to the exclusive contract, the manufacturer becomes a monopoly over them
If there is a second manufacturer then P=c from the Bertrand Paradox, and q is given by qE
The consumer surplus the dealer receives from not signing up to the deal is much larger than the one it gets from signing up to the deal
The incumbent manufacturer must be able to compensate the dealer by the trapezium between wm and c (i.e. the CS the dealer loses by signing up to the exclusive deal)
The profit of the incumbent is smaller than the area it needs to compensate (profit is given by the square wm and c)
The issue with the Chicago school theory is that it’s based on the manufacturer only selling to one dealer
- if the manufacturer actually sold to many dealers then the manufacturer would receive a lot more profit
A potential entrant needs to be able to supply a sufficient number of buyers in the market to enter
- This might not be possible if the manufacturer has compensated enough of the buyers for signing up to the exclusive dealing contract
-This means only some of the buyers will be compensated while others will be harmed as a result of this dealing
