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Market power, price discrimination, and allocative efficiency in intermediate-goods markets

Roman Inderst

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Greg Shaffer

RAND Journal of Economics Vol. 40, No. 4, Winter 2009 pp. 658¡V672

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This paper considers a monopolistic supplier¡¦s optimal choice of two-part tariff contracts when downstream firms are asymmetric. We find that the optimal discriminatory contracts amplify differences in downstream firms¡¦ competitiveness. Firms that are larger¡Xeither because they are more efficient or because they sell a superior product¡Xobtain a lower wholesale price than their rivals. This increases allocative efficiency by favoring the more productive firms. In contrast, we show that a ban on price discrimination reduces allocative efficiency and can lead to higher wholesale prices for all firms. As a result, consumer surplus, industry profits, and welfare are lower.