The Welfare Effect of Input Price Discrimination with Horizontally Differentiated Final Products

We analyze the welfare effect of input price discrimination in a horizontally differentiated final-goods market. Previous studies assuming downstream firms competing with homogeneous goods have shown that input price discrimination lowers social welfare by reducing production efficiency. On the other hand, Hahn and Kim(2018) recently showed that input price discrimination can improve social welfare by increasing consumption and production efficiencies when the final-goods market is vertically or horizontally differentiated and consumers have heterogeneous preferences for the products. In contrast, this paper shows that even if the final goods are spatially differentiated, input price discrimination always reduces social welfare as long as all consumers participate and the participation constraint is binding in the middle of the consumer distribution in equilibrium. This result highlights that the welfare effect of input price discrimination in the differentiated final-goods market critically depends on the type of consumer participation constraint, which provides useful implications for competition policy towards the third-degree price discrimination in intermediate-goods markets.