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Countervailing power and input pricing: When is a waterbed effect likely?

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  • Stephen P. King

Abstract

A downstream firm with countervailing power can extract a reduced price from an input supplier. A waterbed effect occurs if this price reduction leads the input supplier to raise the price that it charges another downstream firm. Policy makers have been concerned that this waterbed effect could undermine downstream competition, and it was considered in detail in the 2008 UK grocery inquiry. This paper presents a simple but parsimonious model to investigate if and when a waterbed effect may arise. It shows that the effect may arise through optimal pricing behaviour, but that this critically depends on the nature of upstream technology, downstream competition and consumer demand. In particular, downstream competition tends to work against a waterbed effect, but convex upstream costs support the effect. The analysis is complementary to recent academic work on the waterbed effect that focuses on bargaining constraints.

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File URL: http://www.buseco.monash.edu.au/eco/research/papers/2012/2712countervailingpowerking.pdf
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Paper provided by Monash University, Department of Economics in its series Monash Economics Working Papers with number 27-12.

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Length: 23 pages
Date of creation: Sep 2012
Date of revision:
Handle: RePEc:mos:moswps:2012-27

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  1. Inderst, Roman & Wey, Christian, 2002. "Buyer Power and Supplier Incentives," CEPR Discussion Papers 3547, C.E.P.R. Discussion Papers.
  2. Inderst, Roman & Wey, Christian, 2003. " Bargaining, Mergers, and Technology Choice in Bilaterally Oligopolistic Industries," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 1-19, Spring.
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