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Formal merger analysis typically ignores the possibility that both prices and quality levels may be endogenous. This paper extends the traditional analysis of mergers to include both quality and price effects. Based on simulations, we find that mergers can either raise or lower the quality levels of the merging firms; non-merging firms always raise their quality levels. We find that while the standard upward pricing pressure index is a good predictor of the qualitative results of merger simulations, the equivalent index for quality performs poorly.

We describe a model of entry timing assuming that a second mover can benefit from observing the experience of a first mover. We focus on how market attractiveness characteristics such as size and cost affect the time until first entry. The effects depend on whether the number of participants is exogenous or endogenous. In the former case, a more attractive market leads to earlier entry. In the latter case, it leads to later entry. Treating the number of firms as an integer, free entry leads to non-monotone, but testable, effects of market attractiveness on entry timing.

Consider a monopolist in one market that faces competition in a second market. Bundled loyalty discounts, in which customers receive a price break on the monopoly good in exchange for making all purchases from the monopolist, have ambiguous welfare effects. Such discounts should not always be treated as a form of predatory pricing. In some settings, they act as tie-in sales. Existing tests for whether such discounts violate competition laws do not track changes in consumer surplus or total surplus. We apply a new test to an illustrative example based on SmithKline that assumes the “tied” market has homogeneous goods. If the tied market is characterized by Hotelling competition, bundling by the monopolist causes the rival firm to reduce its price. In numerical examples, we find that this can deter entry or induce exit.

We study two vertical constraints on pricing which have received little study. A vertical MFN (“VMFN”) refers to an MFN on retail prices that is sought by an upstream manufacturer. A vertical margin constraint (“VMC”) refers to a requirement that the margin earned by a retailer on a manufacturer’s product not exceed what the retailer earns on a rival manufacturer’s product. Vertical agreements containing these constraints are found in the soft drink and cigarette industries. We study these vertical constraints in the context of two asymmetric manufacturers. In this setting, only the larger manufacturer uses the VMFN. We characterize pure and mixed strategy equilibria and find, as have others, that the VMFN raises prices, relative to a benchmark case. The VMFN harms the retailer and the small manufacturer, helping the larger manufacturer. This can lead to foreclosure of the small manufacturer. The VMC has opposite effects, leading to lower prices and higher retailer profits than in the benchmark case. It requires pre-commitment by the retailer in order to be used.

What price should downstream entrants pay a vertically integrated incumbent monopoly for use of its assets? Courts, legislators, and regulators have at times mandated that incumbent monopolies lease assets required for the production of a retail service to entrants in efforts to increase the competitiveness of retail markets. This paper compares two rules for pricing such monopoly inputs: marginal cost pricing (MCP) and generalized efficient component pricing rule (GECPR). The GECPR is not a fixed price, but is a rule that determines the input price to be paid by the entrant from the entrant's retail price. Comparing the retail market equilibrium under MCP and GECPR, the GECPR leads to lower equilibrium retail prices. If the incumbent is less efficient than the entrant, the GECPR also leads to lower production costs than does the MCP rule. If the incumbent is more efficient than the entrant, however, conditions may exist in which MCP leads to lower production costs than does the GECPR. The analysis is carried out assuming either Bertrand competition, quantity competition, or monopolistic competition between the incumbent and entrant in the downstream market.

We propose a model of Bertrand competition in which consumers choose firms based on prices and qualities. Service quality depends on congestion, which is a function of capacity and output. We first present theoretical properties of the model. Next, we calibrate the model to the wireless industry and use it to evaluate the impacts of changes in spectrum allocation on consumer welfare and profits. Simulations of the model show that when one firm acquires more spectrum, consumer welfare at all firms increases due to congestion externality effects. We find that a transfer of spectrum from one firm to another can either raise or lower consumer welfare at the firms not involved in the transaction, again due to externality effects. Where it is possible to compare the results of our model to the wireless industry, they are consistent with the data. We also explore some possible effects of the upcoming 2016 spectrum auctions.

A regulated upstream monopolist provides an input to firms in a downstream market. If the monopolist enters the downstream market, a natural concern is that it will act so as to raise its downstream rivals' costs. An offsetting incentive is that a higher downstream price will reduce demand for the input, which reduces the monopolist's profit. Conditions under which one incentive dominates the other are derived. The monopolist may desire to lower its downstream rivals' costs rather than raise them. These findings suggest that regulatory policy towards such downstream entry should not focus exclusively on the ability to discriminate.

We examine the incentives for abuse under rate-of-return (ROR) and incremental surplus subsidy (ISS) regulation. Abuse consists of expenditures by the regulated firm that provide private benefits, but do not reduce production costs. We show that ISS regulation provides efficient incentives for owners of the regulated firm to limit abuse by subordinates. We also prove that abuse by owners of the firm will generally be greater (smaller) under ROR regulation than under ISS regulation when consumer demand for the regulated product is inelastic (elastic). Furthermore, we show that to limit abuse and improve welfare under ROR regulation, it can be advantageous to “ignore” available information about consumer demand.

In this paper we characterize the Pareto-optimal set of non-linear pricing schedules when non-negative weights are assigned to each customer type. Our analysis first compares general non-linear tariff schedules and sets of self-selecting two-part tariffs, when there are two customer types and the cost function is linear. We then derive optimal sets of two-part tariffs for arbitrary numbers of customer types and general cost functions. We also consider the sustainability of non-linear pricing schedules under the threat of entry of rival firms.

We analyze an oligopolistic pricing and entry model in which there is a sunk cost of entry and in which firms' outputs are homogeneous. Firms' pure strategies consist of a binary entry decision, and conditional on entry a uniform or non-linear price schedule. There does not exist a pure strategy Nash equilibrium in this model, so we analyze the symmetric mixed strategy equilibrium. The main result is that if there exists a positive sunk cost of entry, then an increase in the number of potential competitors puts more probability weight on higher prices. This result is counter to the usual intuition that underlies current antitrust policy.

We study optimal nonuniform pricing in a setting where a customer's demand at the start of a billing period contains a random variable whose realization becomes known by the end of the billing period. In this context, an optional calling plan is a tariff which the consumer must select based on his/her expectations about the random variable, whereas, under a tapered tariff, the consumer's choice of usage charge is made after he/she knows the realization of the random variable. We show that for low to moderate levels of uncertainty about the random variable entering the demand function, the optional calling plan approach to nonuniform pricing yields higher expected profit than does the tapered tariff approach, given risk-neutral consumers. We illustrate this finding with a case study and argue that it is consistent with the historical evolution of tariffs in the interexchange telecommunications market.

What price should entrants pay an incumbent monopoly for use of its assets? Courts, legislators, and regulators have at times mandated that incumbent monopolies lease assets required for the production of a retail service to entrants in efforts to increase the competitiveness of retail markets. This paper compares two rules for pricing such monopoly inputs: marginal cost pricing ("MCP") and Generalized Efficient Component Pricing Rule ("GECPR"). The GECPR is not a fixed price, but is a rule that determines the input price from the entrant's retail price. Comparing the retail market equilibrium under MCP and GECPR, the GECPR equals or dominates MCP in terms of allocative efficiency. If the incumbent is less efficient that the entrant, the GECPR also dominates MCP in allocative efficiency. If the incumbent is more efficient than the entrant, however, conditions may exist in which MCP leads to lower production costs than does the MECPR, so that the total surplus may be higher under MCP. The analysis is carried out assuming either Bertrand competition, quantity competition or monopolistic competition between the incumbent and entrant.

Currently, the FCC is refining a proposal to regulate the access services of the local exchange carriers (LECs) under a price-cap scheme, modifying rate-of-return regulation. See FCC (1988, 1989). One element of the proposal is that new services be treated for tariff review purposes in a manner quite similar to the FCC’s Optional Calling Plan Order, which set out a net revenue test for approval. This net revenue test would require that (1) a new service must be projected to increase net revenue for the service subject to price-cap regulation and that (2) this increase be projected to occur within the lesser of two time periods: 24 months from the incorporation of the new service into a price filing, or 36 months from the introduction of the services. This showing must be accompanied by net revenue projections which include marginal costs, price elasticity, and cross-elasticity effects.1

We examine profit-maximizing nonlinear pricing under a stylized version of the FCC's price-cap plan for AT&T, whereby the firm's average revenue in each period is constrained not to exceed some fixed level. When average revenue in each period is calculated as the ratio of total revenue in that period to output in the preceding period (as in the FCC's plan for AT&T), incentives are created for the firm to engage in strategic nonlinear pricing. These incentives can lower both consumers' surplus and total surplus under price-cap regulation. We propose alternative implementations of price-cap regulation that eliminate these incentives for strategic pricing. We also examine whether current profits should influence future revisions of the cap. We show that small amounts of such linkage can enhance total surplus, due to pricing distortions that arise under price-cap regulation.

This paper studies transfer prices and compensation mechanisms in a principal-agent model with moral hazard and private information by the agent. Production requires unobservable effort by the agent and a purchased input. In general, it is optimal for the principal to create an internal market for the input and charge the agent a tax or subsidy that differs from the market price. Conditions are found under which the optimal compensation function is given by the difference between a nonlinear "revenue" function depending only on output and a nonlinear transfer pricing function that depends only on the amount of the purchased input. Copyright 1991 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

The authors propose a regulatory mechanism, called the incremental surplus subsidy (ISS) scheme, that can be implemented even when the regulato r has no knowledge of the monopolist's cost structure. The regulator need only share the firm's knowledge of demand (which may be imperfec t) and be able to observe (with a lag) the firm's expenditures. The I SS scheme induces the firm to set marginal cost prices, to minimize p roduction costs, and to undertake efficient investment levels. It als o severely limits the firm's rents, and eliminates them altogether if the firm's discount rate is known. Copyright 1988 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

The existing literature on public utility pricing with stochastic demand has reached no consensus on the profitability of pricing and investment policies which maximize expected surplus. This note contributes a theorem which resolves the issue and contains previous results as special cases.

In an example, we compute optimal consumption policies with wage uncertainty and find that when the time horizon is large enough, wage uncertainty may be ignored.

A regulatory incentive mechanism is presented in which the regulated firm has superior information about both cost and demand, compared to the regulator. The mechanism leads to truthful revelation of the demand function and extracts all rents due to private demand information in a nondistorting way. The scheme assumes that the regulator can observe lagged expenditures by the firm. This mechanism leads to efficient pricing, operating, and investment behavior by the firm. Finally, it is shown that the mechanism is closely related to recent proposals for price-cap regulation and that under certain assumptions simple modifications of these proposals will lead to the mechanisms discussed herein.

In models of a multiproduct firm with increasing returns to scale, prices are not set equal to marginal costs. Ramsey prices, which are inversely proportional to the elasticity of demand when demands are independent, are usually used in this situation. An analogous pricing system has been derived for a single commodity firm charging different "marginal" prices, depending upon the amount consumed. Our main purpose is to study properties of such nonuniform price functions for a multi-product firm which faces consumers who are differentiated by a single characteristic. We show, using this simplification, that a multiproduct monopolist offers a nonuniform price schedule--analogous to the single product nonlinear price system--on a one-dimensional path, along which consumers choose their optimal bundles.

We consider optimal nonuniform pricing schedules, where the price depends upon the amount purchased. Such schedules are regularly used by public utilities and other services. Welfare-optimal nonuniform prices are related to the theory of optimal uniform prices developed by Ramsey. We characterize situations in which upward or downward discontinuities in pricing schedules are optimal. Our results are applicable to a number of related problems, including optimal taxation, insurance, and incentives. Economic theory has confined most of its attention to markets with uniform prices, in which the price per unit charged is invariant to the level of a customer's purchases. This focus is warranted when goods are resellable, since any attempt to charge nonuniform prices could be circumvented by reselling amongst customers. But when goods are not resellable, nonuniform prices are not only possible but common. Public utilities have declining block pricing, with lower unit charges for large levels of consumption. Many agencies providing services, including communications, transportation-even education-use two-part pricing, with a fixed entry or retainer charge, and a further charge per unit consumption. Nonuniform price schedules can be expected to be ever more common as services become a larger fraction of total output. The increasing prevalence of nonuniform pricing policies have made them the focus of recent public and economic attention. Oi (1971), Feldstein (1972), and Ng and Weisser (1974) have examined optimal two-part pricing policies. Leland and Meyer (1976) examine block pricing, and show by example that optimal welfare policies may require nonuniform prices if zero profit constraints are binding. In this paper, we consider arbitrary nonuniform pricing policies, using variational techniques. Two-part and block pricing schedules are, of course, special cases of the environment we consider. The work most closely related to our examination is the seminal paper by Spence (1978) and subsequent analysis by Roberts (1979). Spence, however, does not pay explicit attention to the key role played by constraints on optimal pricing schedules. Roberts considers upward price discontinuities which lead to bunching of consumers at a given level of consumption, but not downward price discontinuities, which lead to regions in which no consumer chooses to consume (gaps). Bunching or gaps may appear in the optimal price schedule even when underlying demand and cost functions are smooth and well behaved. The prevalence of discontinuous pricing schedules (e.g. the block pricing structures of public utilities) argues that these questions are of practical as well as theoretical interest.