Production efficiency, input price discrimination, and social welfare

Abstract

This paper re-examines the welfare implications of input price discrimination by considering the possibility of the structural change in the final goods market. When the marginal cost difference is moderate, price discrimination is more socially desirable as the upstream firm serves more downstream firms under price discrimination than uniform pricing. Surprisingly, when the marginal cost difference is sufficiently large, although the upstream monopolist serves more downstream firms and more outputs are produced under price discrimination than uniform pricing, the social welfare is lower under price discrimination. This result runs against those prevailing in the literature without market structural change.

Keywords:

• production efficiency
• price discrimination
• vertically related markets

JEL Codes:

• L13
• L16
• L43

Acknowledgement

This paper was presented at the International Trade Workshop, College of Social Sciences, National Taiwan University.

We would like to thank Hong Hwang, Chin-Sheng Chen, and other participants of the workshop, as well as an anonymous referee, for their helpful comments. The usual disclaimer applies.

Notes

1.

2. We shall relax this assumption and discuss the independent final good markets case in Section 5.

3. The second-order condition is necessarily satisfied given the linear demand function.

4. The profit of the upstream firm under discriminatory pricing is necessarily no less than that under successive monopoly as it can always set w ₁ = w ₂ = w_M under discriminatory pricing.

5. By substituting = w ₁ = w ₂ into in (8), the outputs of Firm 2 is negative if .