Cost Reduction in Vertically Related Industries: Integration versus Nonlinear Pricing,
Abstract
A continuing concern in the study of vertical integration is whether ownership integration is necessary or sufficient to achieve all possible cost savings in the operation of a vertically related sequence of production processes. Integration-or any other mechanism for controlling intermediate markets--must accomplish two functions: to coordinate production and to divide revenues among the various levels. The analysis here compares integration and several other revenue division mechanisms in terms of the production efficiency they induce. The intermediate market control mechanisms compared are simple (linear) pricing; two forms of nonlinear pricing, a royalty scheme and a two-part tariff; and vertical integration. Under a royalty scheme, the purchaser of an intermediate good pays a price per unit of intermediate good brought plus a royalty fee for each unit of final good produced. Under a two-part tariff, the intermediate good buyer pays a lump-sum access charge in addition to the per-unit price. Cost reduction serves the monopolist interests whether his goal is to maximize profits or welfare. Pricing the intermediate good at marginal cost may either not be feasible (e.g., because of a need to cover the costs of an increasing returns upstream production process) or may not be desirable (e.g., under profit maximization). Cost savings at a constant final output level are sufficient for profit or welfare gains.
Document Details
- Document Type
- Technical Report
- Publication Date
- May 01, 1983
- Accession Number
- ADA152757
Entities
People
- H. C. Ouirmbach
Organizations
- RAND Corporation