The Welfare Effects of Third Degree Price Discrimination In Intermediate Good Markets: The Case of Bargaining

This paper examines the welfare effects of third degree price discrimination by an intermediate good monopolist selling to downstream firms with bargaining power. One of the downstream firms (the “chain store”) may have a greater ability than rivals to integrate backward into the supply of the input. In addition to this outside option, the firms’ relative bargaining powers depend on their disagreement profits, bargaining weights, and concession costs. If the chain’s integration threat is not a credible outside option, and if downstream firms cannot coordinate their bargaining strategies, then price discrimination reduces input prices to all downstream firms. Economist, U.S. Federal Trade Commission. The views expressed herein are my own and do not purport to represent the views of the Federal Trade Commission or any Commissioner. I thank Ian Gale, Dan Gaynor, Steve Matthews, John Panzar, Greg Shaffer, Abraham Wickelgren, and seminar participants at Northwestern University and the University of Michigan for helpful comments. I take full responsibility for any errors. The author can be reached at [email protected] or [email protected]. “When a degree of non-transferability...sufficient to make [price] discrimination profitable is present, the relation between the monopolistic seller and each buyer is, strictly, one of bilateral monopoly. The terms of the contract that will emerge between them is, therefore,...subject to the play of that ‘bargaining’...” (A.C. Pigou, 1932, 278). Price discrimination policy in the U.S. focuses mainly on intermediate good markets in which buyers have bargaining power. In fact, the primary U.S. law governing price discrimination, the Robinson-Patman Act (1936), arose from concerns that large downstream firms (e.g., chain stores) were harming smaller rivals by negotiating larger discounts with suppliers. In the first formal analysis of buyer-specific price discrimination policy in intermediate good markets, Michael L. Katz (1987) examined the effects of forbidding third degree price discrimination when the bargaining power of chain stores comes from their ability to threaten credibly to integrate backward into the supply of the intermediate good. For downstream markets characterized by Cournot oligopoly, he showed that “if there is no integration under either regime [i.e., whether price discrimination is allowed or forbidden], then total output and welfare are lower when price discrimination is practiced than when it is forbidden.” (Katz, Proposition 1). This is an important result for public policy toward price discrimination. Until this result, the Robinson-Patman Act had received little support in the economics literature. Although most of the Robinson-Patman claims brought by the FTC have been against sellers, it was well understood when the law was passed that the discriminating seller was often the “innocent victim” of the buyer’s bargaining power. See, for example, Phillip Areeda and Louis Kaplow (1988), pp. 979-80. Congress made this recognition explicit with Section 2(f) of the Act, which makes it unlawful for a buyer “knowingly to induce or receive a discrimination in price which is prohibited by this section.” It should be noted that Katz does not argue that his analysis provides support for the enforcement of the Robinson-Patman Act. However, prior to Katz’s article, the Robinson-Patman Act was almost universally criticized by economists as an anticompetitive law. See, for example, Marius Schwartz (1986). Until Katz’s article, the formal analysis of buyer-specific price discrimination had focused on the case of independent demands (e.g., Joan Robinson (1934), Richard Schmalensee (1981), Hal Varian (1985)). Subsequent theoretical work on third degree price discrimination has focused on discrimination by a take-it or leave-it monopolist (e.g., Marius Schwartz (1990) and David A. Malueg (1993) obtain additional results for final good markets, and Patrick DeGraba (1990) and Yoshihiro Yoshida (2000) do so for input markets.) There has been work on the effects of price discrimination in input markets under buyer-specific nonlinear contracts. See Daniel P. O’Brien and Greg Shaffer (1994). Best-customer clauses have effects that are similar to a policy against price discrimination. These clauses have been examined by Thomas Cooper and Theodore Fries (1991) for the case of linear pricing and independent demands, and by Patrick DeGraba and Andrew