Cost reduction in vertically related industries: integration versus nonlinear pricing

Herman Quirmbach

Expert InsightsPublished 1983

This paper examines the incentives of the monopoly producer of an intermediate good either to integrate into a contestable industry it serves or to impose either a royalty scheme or a two-part tariff. The paper focuses on cost reduction rather than profit maximization incentives. With free entry downstream, independent downstream firms earn zero profit. Thus, the monopolist's profit is the industry profit, and any move which lowers industry costs while (for comparison) yielding the same final good demand must thereby improve the monopolist's profit. It is further shown that cost reduction is not just sufficient but also locally necessary for profits to increase under any of the three alternatives.

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Quirmbach, Herman, Cost reduction in vertically related industries: integration versus nonlinear pricing. Santa Monica, CA: RAND Corporation, 1983. https://www.rand.org/pubs/papers/P6839.html.
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