Optimal Privatization in a Vertical Chain: A Delivered Pricing Model
The chapter considers the introduction of a mixed ownership firm into a classic model in which downstream firms locate strategically so as to achieve accommodating upstream price reductions. These reductions happen endogenously but the strategic locations
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9.1
Introduction
In an important earlier paper Gupta et al. (1994) examine the ability of downstream firms to strategically use location decisions to force an upstream monopoly to reduce its input price and transfer profit downstream. This transfer happens endogenously in equilibrium but generates large welfare loses. Additional research builds on this model to show that transport cost itself can also be set inefficiently high by downstream firms choosing a more costly transport mode. This forces the
J. S. Heywood Department of Economics, University of Wisconsin-Milwaukee, Milwaukee, WI, USA S. Wang Institute of Economics, Chinese Academy of Social Sciences, Beijing, China G. Ye () Institute of Economics, Hainan University, Haikou, Hainan, China e-mail: [email protected] © The Author(s) 2020 S. Colombo (ed.), Spatial Economics Volume I, https://doi.org/10.1007/978-3-030-40098-9_9
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same accommodating behavior by the upstream monopoly (a lowering of the input price and a profit transfer downstream) and a similar loss of welfare (Gupta et al. 1995, 1997). The fundamental insight of these showings is that downstream firms often face a spatial market that is largely irrelevant to an upstream firm. Thus, downstream firms make a product that has a high transport cost or for which horizontal differentiation is critical. Yet, the upstream firm produces a small critical input for which transportation costs are irrelevant. Indeed, it may provide intellectual property with no transport cost at all. Alternatively, while the downstream product faces consumers with horizontally differentiated preferences (proxied by distance in a spatial model), these simply need not apply to the input. Thus, consumers may care greatly about the characteristics of cell phones but these preferences may be largely irrelevant to the manufacturer of the basic chips. In such circumstances, the primary concern of the upstream firm is to avoid setting a price so high that it results in a dramatic loss of customers downstream. Given this concern, Gupta et al. (1994) show that the downstream firms can locate strategically to make such a dramatic loss of customers more likely for a given price increase. This, in turn, causes the upstream firm to lower its input price. We return to these earlier models of vertical rivalry and incorporate the possibility that one of the downstream firms is a “mixed ownership firm.” The enormous literature on public firms and mixed oligopolies has largely grown up since these early location models and has much to offer. The basic view is that a public firm regulates by participating in a private oligopolistic market. While the private firms maximize profit, the public firm sets quantity or some other choice variable to maximize social welfare. In a quantity game the public firm can increase consumer surplus by increasing total production. Yet, the assumption in this literature is that the government-owned firm produces at elevated costs.1 In a seminal article Matsumura (1998) recognizes t
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