Wednesday, March 16, 2016

Profitable Double Marginalization

Kevin Bryan, University of Toronto - Strategic Management and Erik Hovenkamp, Northwestern University, Department of Economics have an interesting paper on Profitable Double Marginalization.

ABSTRACT: There is a longstanding consensus that, if producers of complementary goods apply markups noncooperatively, their joint profits will fall, suggesting they would benefit from integration. On the contrary, we show that double marginalization inadvertently enhances joint profits in many familiar competitive environments where the firms face third party competition. For example, in a vertical relationship, the upstream markup incidentally engenders credible (albeit imprecise) commitment to less competitive behavior by the downstream firm, and this may elicit an accommodating response from downstream rivals -- e.g. they may raise their own prices or scale back production. The benefit of this indirect "strategic effect" may outweigh the well-understood direct harm from double marginalization, even if the upstream firm sets a monopoly price. In a more game-theoretic discussion, we consider double marginalization as a strategic device, in which case it is intimately related to other practices aimed at distorting a downstream agent's decisions, such as vertical restraints or delegation. In all cases, joint profits are maximized by inducing the downstream firm to act as if it has a so-called "consistent conjecture," meaning it internalizes strategic effects. Interestingly, when upstream competitors do this in parallel, they induce a consistent conjectures equilibrium (CCE), evincing a strong link between ordinary "Nash games" and the CCE concept.

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