Regulated input price, vertical separation, and leadership at free entry markets joint work with Noriaki Matsushima OT2012

Network Industries Electricity Supply, Electric Power Industry Gas Distribution Telecom and Telecommunication Postal Service, Overnight Delivery Railway Water Supply Airline-Airport OT2012　

Electricity Supply Consumers Power Plants Transformer Substation 規制政策　規制の経済学

Essential Facilities Power Plants ~ no significant economy of the scale. →Competition is possible. Network ~ significant economy of the scale. →Natural monopoly, essential facility OT2012　

competition between downstream firms Upstream Firm Downstream Firm 2 Downstream Firm 1 Upstream Firm Market OT2012　

competition between downstream firms Suppose that the upstream firm sets the unit part is equal to the marginal cost. →The resulting price is lower than the joint-profit maximizing monopoly price. ⇒(if downstream firms are symmetric), the upstream firm sets a higher unit price so as to induce the monopoly price (Matsumura 2003). Downstream competition does not matter if the input price is not regulated. ⇒Access Charge Regulation ~ Cost-Based Pricing. OT2012　

Manipulation In principle, the access charge (input price) is regulated and there is no room for manipulation. In practice, the network facility holders can affect this price. Lobbying, Manipulation of Accounting, and so on. Lobbying requires costs. OT2012　

Vertical Integration Network Holder Downstream Firm 2 Upstream Firm Market OT2012　

Vertical Separation Network Holder Downstream Firm 2 Downstream Firm 1 Upstream Firm Market OT2012　

Our paper Does the vertical separation reduce the incentive for manipulation of the access charge (and so reduce the resulting input price)? Does the above result depends on whether the incumbent (former monopolist) is the Stackelberg leader or not ? OT2012　

The Model Firm 0 ~ Network Holder Firm 1…n ~ Downstream firms Firm 1 ~ Former monopolist Firm 2…n ~ New Entrants Free entry market ~ n is determined by zero-profit condition. Vertical Integration→Firm 0 and Firm 1 maximize joint profits. Vertical Separation→Firm 0 and Firm 1 maximize their own profits. Input price depends on firm 0’s efforts for manipulation. OT2012　

The Model General Demand ~ only Strategic Substitutes condition and Stability Condition are imposed. No cost asymmetry between the incumbent (firm 1) and new entrants Constant marginal cost→Cost is f yi (yi is firm I’s output) OT2012　

The Model ~ Cournot (1) Firm 0 chooses the input price f >0. (2) Each new entrants chooses whether or not to enter the market. (3) After observing n, firms 1-n face Cournot competition. Under vertical separation, firms 1-n chose the same output level (y1=y2) in equilibrium. Under vertical integration, y1 (>,=,<) y2. OT2012　

The Results ~ Cournot Lemma 1 (i) Consider the equilibrium outcome in the second stage subgame given f. (i) The vertical separation does not affect the output of each new entrant (ii) and so it does not affect the equilibrium price of the final product. (iii) The equilibrium price is increasing in f. Proposition 1. Vertical separation reduces the input price and so reduces the price of the final product. OT2012　

Intuition ~ Cournot Lemma 1 (i) (ii) ← We can easily guess from the result in mixed oligopolies. The degree of privatization (and so the output of the public firm) does not affect the equilibrium price. OT2012　

Free entry equilibrium P private firm's residual demand private firm's AC Y private firm's output OT2012

a decrease in θ P private firm's residual demand private firm's AC Y Y private firm's output long run ~ reduction of the number of private firms OT2012

Intuition ~ Cournot Proposition 1. Vertical separation reduces the input price and so reduces the price of the final product. An increase in f reduces total output. An increase in f induces production substitution from new entrants to firm 1 and increases the joint profit of firms 0 and 1. Vertical integration increases the incentive for raising f and thus increases the final product price. OT2012　

The Model ~ Stackelberg (1) Firm 0 chooses the input price f. (2) Firm 1 chooses its output level. (3) After observing firm 1’s output, each new entrant chooses whether or not to enter the market. (3) After observing n, Firms 2-n face Cournot competition. OT2012　

The Results ~ Stackelberg Lemma 2 (i) Consider the equilibrium outcome in the second stage subgame given f and y1. (i) Neither the vertical separation nor the leadership affects the output of each new entrant and (ii) and so neither affects the equilibrium price of the final product. (iii) The total output does not depend on y1. Lemma 3 No entry takes place. Proposition 2. Vertical separation raises the input price and so reduces the price of the final product. OT2012　

Intuition ~ Stackelberg Lemma 3 No entry takes place. The price is independent of y1→Firm 1 is the price taker. Complete entry deterrence appears in equilibrium. OT2012　

Intuition ~ Stackelberg Proposition 2. Vertical separation raises the input price and so increases the price of the final product. Under both vertical separation and integration, firm 1 is the monopolist. An increase in f reduces the profit of firm 1. Thus, joint-profit maximizer has a smaller incentive for raising f. OT2012　

Corner solution vs Interior solution in Stackelberg Firm 1 is the price taker→Firm 1 is the monopolist (no new entry) This result crucially depends on the assumption of constant marginal cost. If marginal cost is increasing, entries take place in equilibrium. OT2012　

The Results under Increasing Marginal Costs~ Stackelberg Proposition 3. Vertical separation raises the input price and so increases (decreases, does not affect) the price of the final product if p’’ < (>, =) 0. Interesting property in general context: ∂p/∂f =(<,>) 1 if p’’=0(>,<) at free entry markets. OT2012