Differential Pricing in Intermediate Good Markets

Abstract

This paper studies differential pricing by an upstream monopolist whose cost to supply the intermediate good differs across buyers in the downstream. It is shown that, different from third degree price discrimination based on the downstream firms' cost of transforming the intermediate good into the final good, differential pricing shifts production efficiently. Thus if total output is weakly increased under differential pricing than under uniform pricing, as is true for weakly convex final market demand functions, social welfare is strictly improved. The analysis is extended to the case in which both the upstream monopolist's cost to serve the downstream firms and the downstream firms' cost to produce the final good differ.

Keywords: Differential pricing; Uniform pricing; Intermediate good; Welfare

JEL Classification: L1; L4