Double marginalization explained

Double marginalization is a vertical externality that occurs when two firms with market power (i.e., not in a situation of perfect competition), at different vertical levels in the same supply chain, apply a mark-up to their prices.[1] This is caused by the prospect of facing a steep demand curve slope, prompting the firm to mark-up the price beyond its marginal costs.[2] Double marginalization is clearly negative from a welfare point of view, as the double markup induces a deadweight loss, because the retail price is higher than the optimal monopoly price a vertically integrated company would set, leading to underproduction.[3] Thus all social groups are negatively affected because the overall profit for the company is lower, the consumer has to pay more and a smaller amount of units are consumed. 

Example

Consider an industry with the following characteristics - \text\quad \mathrm=10-p

\text\quad c= C'(\mathrm)=2

\text\quad \pi = p \cdot \mathrm - c \cdot \mathrm

In a monopolistic situation with a single integrated firm, the profit-maximizing firm would set its price at

p=6

, resulting in a quantity of

Q=4

and a total profit of

\pi=16

.

In a non-integrated scenario, the monopolist retailer and the monopolist manufacturer set their price independently, respectively

pr

and

pm

.

(pr-pm)(10-pr)

. Thus, to maximize profits, it will set its price at

pr=5+0.5pm

.

(pm-2)(5-0.5pm)

. Thus, it will set its price at

pm=6

. The retailer will respond by setting its price at

pr=8

.

Q=2

. The manufacturer's profit is 8, and the retailer's profit is 4.

Not only is the total profit lower than in the integrated scenario, but the price is higher, thus reducing the consumer surplus.

Solutions

There are numerous mechanisms to prevent or at least limit double marginalization. These include, among others, the following.

Note that the above mechanisms only solve the problem of double marginalization; from an overall welfare point of view, the problem of monopoly pricing remains. It should also be noted that while some of the solutions presented above, such as mergers, have a positive effect in minimizing the double markup present within the vertical competition, but it damages the horizontal competition.[8]

Notes and References

  1. Gabrielsen, Tommy., Johansen, Bjorn Olav., Shaffer, Greg. (2018). Double Marginalization and the Cost of Shelf Space, Konkurransetilsynet
  2. Badasyan, Narine., Goeree, Jacob K., Hartmann, Monica., Holt, Charles., Morgan, John., Rosenblat, Tanya., Servatka, Maros., Yandell, Dirk. (2005). Vertical Integration of Successive Monopolists: A Classroom Experiment, National Science Foundation and the University of Virginia Bankard Fund.
  3. Mukherjee, Kankana. (2015). “Double Monopoly Markup” Wiley Encyclopedia of Management
  4. Meyer, Christine Siegwarth., Wang, Yijia (Isabelle). (2011). “Determining the Competitive Effects of Vertical Integration in Mergers” Economics Committee Newsletter
  5. Belleflamme, Paul., Peitz, Martin. (2009). “Part IV. Theory of competition policy” Cambridge University Press
  6. Bach, Christian W. (n.d.). “Vertical Restraints” University of Liverpool & EPICENTER
  7. Morgan, John. (2003)."Double Marginalization" Berkeley Economics - University of California
  8. "Competitive Effects" Federal Trade Commission