An Analysis of Upstream and Downstream Interaction, From a View of Principal-Agent Relationship∗

This paper discusses pricing strategies and production of upstream and downstream firms from the view of a principal-agent relationship. As an agent, the upstream firm offers intermediate products and allocates them between downstream firms according to their incentives. As principals, downstream firms determine the quantities of final products they separately supply based on the competition or cooperation in the final market, which further determine the quantities of intermediate products they need and the incentives they are willing to offer. The research on the dual principals-agent setting indicates a price dispersion of intermediate product because of the difference in productivity of downstream firms. This paper also discusses the possibility of a unified price of intermediate product, a kind of price collusion between downstream firms, and its effect on profits of upstream agent. It is shown that the firm with higher productivity can always benefit from the collusion, and the collusion is usually supported when downstream firms have close technology levels. Furthermore, the analysis on the monopolistic downstream indicates that whether the upstream agent can benefit from the monopoly structure depends on the features of the final market and the difference in productivity of downstream firms. In short, this paper offers some new findings of price and allocation of intermediate products and the supply of final goods, as well as the effects of price commitment and monopoly structure in downstream on them.