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Analysis of Vertical Markets and the Impact on Consumer Welfare

This analysis delves into the impact of vertical markets on consumer welfare, specifically comparing the effects of a single monopolist and two monopolists in the supply chain. The strategies and profits of the Supplier and Retailer are evaluated, highlighting the potential consequences for consumers. The case of a monopoly with a specific price-demand relationship is also explored, with additional considerations for the introduction of a franchise fee.

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Analysis of Vertical Markets and the Impact on Consumer Welfare

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  1. Question: • What is worse for consumers than a Monopolist? • Two monopolists. Vertical Markets: An analysis.

  2. Single Monopolist • As usual, p=12-q and mc=4. • Monopolist profits are (12-q)q-4q=(8-q)q • Monopolist produces q=4 and the price is p=12-4=8. • Monopolist profit is 16. • Another way of looking at it is Monopoly’s profits=revenue – costs. • Choice should set marginal revenue=marginal costs

  3. Two Monopolists:Supplier and Retailer. • Supplier has marginal costs of 4 and charges price ps to Retailer. • Retailer buys q from the supplier at price ps and (charges consumers price pc that would clear the market). • Retailer faces demand curve of q=12- pc. • Profit of Retailer is (12- q- ps)q • Profit of Supplier is q(ps - 4)

  4. Two monopolists • Profit of Retailer is (12- q- ps)q • Retailer sets price q= (12- ps)/2 • Profit of Supplier is (ps - 4)q • Sub. in for q yields (ps - 4)(12- ps)/2 • Supplier sets ps =8 • Retailer sets q=2, so pc = (12-q)=10 • Price to consumers is higher than a single monopolist (10 vs. 8)! • Quantity is less as well (2 vs. 4)!

  5. Solutions. • Allow the Supplier to buy the Retailer. • Allow the Supplier to charge a franchise fee (as with McDonalds). • Supplier charges ps =mc=4. • Supplier charges franchise fee F=16 • What does retailer charge and what are his profits before paying F? • Same as monopolist: pc =8 (q=4), profits 16. • He must pay the franchise fee F. This leaves him w/ no profits. • Supplier gets all the profits. Retailer is barely in business.

  6. Homework • A monopoly has marginal cost of 5 and faces a demand of q=20-p. • What price should he charge to maximize profits? • Let us say it is a vertical market of two firms: supplier and retailer. • What would the price would the supplier charge the retailer? • What would be the price charged to the end consumer? • If the supplier charged a franchise fee in addition to wholesale price, what would they be? • Extra: Solve the above problem for the general case of marginal cost of c facing demand of q=A-p where (A>c).

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