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An Economic Theory of Vertical Restraints

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  • G.F. Mathewson
  • R.A. Winter

Abstract

Vertical restraints imposed by manufacturers on the prices, locations, and sales of retail firms represent a puzzling departure from the simple price-mediated exchange of conventional markets. In this article we analyze the theoretical basis for these restraints. In a setting where retailers inform consumers and are imperfectly competitive, and where a manufacturer has some monopoly power, we identify three potential externalities affecting retailers' decisions. These externalities lead to the failure of simple uniform-price contracts to coordinate the incentives of retailers with the objective of maximizing combined manufacturer and retailer profits. We identify the packages of vertical restraints that are minimally sufficient, under various conditions, to neutralize the externalities and to achieve the joint-profit maximum.

Suggested Citation

  • G.F. Mathewson & R.A. Winter, 1984. "An Economic Theory of Vertical Restraints," RAND Journal of Economics, The RAND Corporation, vol. 15(1), pages 27-38, Spring.
  • Handle: RePEc:rje:randje:v:15:y:1984:i:spring:p:27-38
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    References listed on IDEAS

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    1. Baumol, William J, 1982. "Contestable Markets: An Uprising in the Theory of Industry Structure," American Economic Review, American Economic Association, vol. 72(1), pages 1-15, March.
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    4. Mirman, Leonard J. & Tauman, Yair & Zang, Israel, 1986. "Ramsey prices, average cost prices and price sustainability," International Journal of Industrial Organization, Elsevier, pages 123-140.
    5. ten Raa, Thijs, 1983. "Supportability and anonymous equity," Journal of Economic Theory, Elsevier, vol. 31(1), pages 176-181, October.
    6. John C. Panzar & Robert D. Willig, 1977. "Free Entry and the Sustainability of Natural Monopoly," Bell Journal of Economics, The RAND Corporation, vol. 8(1), pages 1-22, Spring.
    7. William W. Sharkey, 1981. "Existence of Sustainable Prices for Natural Monopoly Outputs," Bell Journal of Economics, The RAND Corporation, vol. 12(1), pages 144-154, Spring.
    8. Faulhaber, Gerald R & Levinson, Stephen B, 1981. "Subsidy-Free Prices and Anonymous Equity [Cross-Subsidization: Pricing in Public Enterprises]," American Economic Review, American Economic Association, vol. 71(5), pages 1083-1091, December.
    9. Baumol, William J & Bailey, Elizabeth E & Willig, Robert D, 1977. "Weak Invisible Hand Theorems on the Sustainability of Multiproduct Natural Monopoly," American Economic Review, American Economic Association, vol. 67(3), pages 350-365, June.
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