Download competition between downstream firms

Regulated input price, vertical
separation, and leadership at free
entry markets
joint work with Noriaki Matsushima
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Network Industries
Electricity Supply, Electric Power Industry
Gas Distribution
Telecom and Telecommunication
Postal Service, Overnight Delivery
Railway
Water Supply
Airline-Airport
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Electricity Supply
Consumers
Power Plants
Transformer
Substation
規制政策 規制の経済学
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Essential Facilities
Power Plants ~ no significant economy of the scale.
→Competition is possible.
Network ~ significant economy of the scale.
→Natural monopoly, essential facility
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competition between downstream
firms
Upstream Firm
Downstream Firm 1
Downstream Firm 2
Market
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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.
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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.
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Vertical Integration
Network Holder
Downstream Firm 1
Downstream Firm 2
Market
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Vertical Separation
Network Holder
Downstream Firm 1
Downstream Firm 2
Market
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Our paper
(1) Does the vertical separation reduce the incentive
for manipulation of the access charge (and so
reduce the resulting input price)?
(2) Does the above result depends on whether the
incumbent (former monopolist) is the Stackelberg
leader or not ?
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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.
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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)
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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.
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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.
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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.
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P
Free entry equilibrium
private firm's residual demand
private firm's AC
0
private firm's output
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a decrease in θ
P
private firm's residual demand
private firm's AC
0
Y
private firm's output
long run ~ reduction of the number of private firms
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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.
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The Model ~ Stackelberg
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.
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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.
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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.
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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, jointprofit maximizer has a smaller incentive for raising f.
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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.
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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.
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