1. G492 Eric Rasmusen, erasmuse@indiana.edu September 29, 2009 Overhead slides on double marginalization The first slide should not be used.

2. Double Marginalization: Producer and Retailer Mark-Ups in Conflict An upstream producer sells to a downstream retailer, who sells to consumers. Both firms have market power. As Separate Firms: Producer: MC = 2, P = 6, Q = 100 Retailer: MC = 6, P = 8, Q = 100 Producer margin: 4 (profit = 400) Retailer margin: 2 (profit = 200) Double margin: 6 (industry profit = 600) Merged: Producer: MC = 2, P = 2, Q = 200 Retailer: MC = 2, P = 6, Q = 200 Producer margin: 0 (profit = 0) Retailer margin: 4 (profit = 800) Double margin: 4 (industry profit = 800) TOTAL PROFIT RISES IF THEY COOPERATE (and consumers benefit too)

3. Double Marginalization Consumer demand marginal cost Quantity Price Optimal Price Double Margin Price Consumer marginal revenue (retailer demand curve) Retailer marginal revenue 8 6 2 Prof. Eric Rasmusen, Indiana University, erasmuse@indiana.edu (October 22, 2008) erasmuse@indiana.edu Double marginalization occurs when upstream producer and downstream retailer both charge such high margins that the ultimate consumer price is above the monopoly price. If the two firms merge, they will reduce the price, benefiting both consumers and themselves As Separate Firms: Producer: MC = 2, P = 6, Q = 100 margin = 4, profit = 400 Retailer: MC = 6, P = 8, Q = 100 margin = 2, profit = 200 double margin = 6, combined profit = 600 Merged: Producer: MC = 2, P = 2, Q = 200 margin = 0, profit = 0 Retailer: MC = 2, P = 6, Q = 200 margin = 4, profit = 800 total margin = 4, combined profit = 800

4. The problem: Each firm wants to have a big margin, but that reduces volume and hurts the other firm. An externality. Consumer Demand Marginal cost Quantity Price Optimal price Double marg. price Consumer marginal revenue (retailers demand curve) Retailers marginal revenue 8 6 2