Journal Article The Noisy Monopolist: Imperfect Information, Price Dispersion and Price Discrimination Get access Steven Salop Steven Salop Federal Reserve Board Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 44, Issue 3, October 1977, Pages 393–406, https://doi.org/10.2307/2296898 Published: 01 October 1977 Article history Received: 01 April 1974 Accepted: 01 October 1976 Published: 01 October 1977

In analyzing deterrence of large-scale entry, two classes of entry barriers may be distinguished. An innocent entry barrier is unintentionally erected as a side effect of innocent profit maximization. In contrast, a strategic entry barrier is purposely erected to reduce the possibility of entry. Two types of innocent barriers may also be distinguished. A postentry absolute advantage has the property that, if entry did occur, the established firm would be at a profit advantage over the entrant. Examples are superior technology or product design, patents, and lower input prices. A preentry asymmetry advantage arises from the fundamental preentry asymmetry between established firm and potential entrant. Before the entrant makes his entry decision, the established firm has already committed resources. This prior existence gives first-move advantages. The preentry asymmetry is independent of symmetry or asymmetry in the rules (the equilibrium concept) of the postentry game that might ensue; even if the postentry game will be played according to Nash-Cournot or entrant-as-leader rules, the preentry leadership

I was asked to report on the effect of economics on the development of antitrust analysis of exclusionary vertical relationships, particularly on the current acceptance of post-Chicago theories of exclusionary market power such as raising rivals' costs (RRC). In order to better understand the role of economics in vertical-restraints law, however, I first analyze acceptance of the free-riding efficiency theory. This provides a second data set. In addition, since antitrust involves balancing market-power harms with efficiency benefits, a more complete picture is achieved. I have reached three basic tentative conclusions. First, developments in economics clearly have an effect on developments in the law. This has been true for both the free-rider and exclusionary-market-power theories. However, the process by which antitrust adopts new economic concepts seems to be subject to a long lag. Second, the process appears to be subject to considerable randomness. It appears to depend on the (partly) random draw of judges, lawyers, and economic consultants. Third, when economic theories are accepted, courts often restrict their engagement with the theories. Assertion sometimes is substituted for economic evidence, and legal conclusions sometimes are overly broad.

I. Introduction, 619.—II. The analysis, 620.—III. Implications, 627.

Salop and David Scheffman (1983) show that firms profitably can gain market power by conduct that raises their competitors' costs. Raising rivals' costs is a more credible route to market power than is predatory pricing because it is not necessary to cause the rivals to exit, no deep pocket is required, and the additional profits are gained immediately. That paper argues that vertical restraints and contracts with input suppliers can be fertile ground for raising competitors' costs. By contracting with one or more suppliers to exclude rivals, either by dealing with them on discriminatory terms or refusing to deal with them altogether, a firm sometimes can increase its rivals' costs. As a result, it can sometimes gain the power to raise price in the market in which it sells output. This type of contract often can be characterized as the purchase of an exclusionary right from the input suppliers. That is, in addition to the purchase of inputs, the predator also purchases the right to exclude (some of) its rivals from access to the suppliers' inputs. Exclusionary rights contracts can exist in a variety of forms. At one extreme are agreements that involve only exclusionary rights; no inputs are exchanged at all. For example, it was reported in Alcoa that at one time Alcoa purchased exclusionary covenants from power companies from which it did not purchase electricity. The contracts involved only the utilities' promises not to sell electricity to other aluminum companies. Such naked exclusionary rights contracts are unusual, of course. Most exclusionary rights are bundled with the sale of inputs. For example, Stroh Beer has alleged that the two major brewers purchase not only advertising time on network sports programs, but also the right to exclude remaining brewers from advertising on those same programs, even though the networks have other advertising time available. It might be argued that such exclusionary conduct would always fail for two reasons: the excluded rivals would have available effective counterstrategies to prevent their own exclusion; and input suppliers would have no incentives to reduce their sales by excluding some customers. These criticisms imply that raising rivals' costs by contracting with suppliers would not be credible. It surely is not true that exclusionary strategies to restrict rivals' input purchases will always succeed in raising their costs. For example, where rivals easily can substitute to other equally cost-effective inputs, or where entry into the production of inputs is so easy that the excluded rivals can efficiently produce the input themselves, then cost-raising strategies will fail. Moreover, where competition in the output market would be sufficient to maintain low prices despite the exit or increased costs of the excluded competitors, then no profit-maximizing firm would spend any resources trying to exclude those rivals. These conditions are discussed in detail in our earlier paper (1985). tDiscussants: Ronald H. Coase, University of Chicago; Gregory K. Down, Yale University; David Sappington, Bell Communications Research and University of Pennsylvania.

This paper shows that firms endowed with monopoly power can utilize an optional service contract form of guarantee as an instrument for effecting a surplus extracting two-part tariff. The monopolist finds it optimal to produce, guarantee and replace defective units, even if a zero defect rate could be achieved at no additional production cost. It is also shown that the price per unit is greater than the “effective” marginal cost; it may even be higher than the pure monopoly price. Moreover the monopolist is unable to extract all of the consumers surplus. Thus, that optional service contract policy can provide an effective yet defensible form of price discrimination as an alternative to possible illegal tie-ins, quantity discounts and simple two-part tariffs.

Consumer protection regulation has come under increasing fire from the Congress, courts, and the business community. In response, regulators have begun to innovate with market interventions that are more compatible with economic incentives. These incentive-compatible techniques include establishing property rights, mandating performance standards (instead of design standards), increasing competition, and encouraging and mandating information disclosure. Information disclosure allows consumer self-protection, compatible with individual preferences. Information is also compatible with sellers' incentives, inducing them to compete on the basis of information disclosed. In addition, this competition increases the incentive to generate and disseminate additional product information, thereby repeating the cycle. In this way, information remedies rely on private economic incentives to achieve regulatory goals, rather than on expensive direct enforcement by the regulator. Diagnosis of an information problem and evaluation of alternative remedies requires a number of steps: analysis of information production and distribution, identification of market failures and their implications for resource allocation in the information and product markets, and analysis of alternative remedies in light of these market failures.

In Ordover, Saloner, and Salop (1990; hereafter OSS) we showed that a downstream duopolist may have an incentive to backward integrate in order to foreclose its downstream rival from a source of upstream supply. As a result of the vertical integration, the downstream rival's input price increases, giving the integrating firm a competitive advantage in the downstream market. Moreover, in equilibrium, the foreclosed downstream rival does not find it profitable to negate these effects by integrating itself. OSS considers a four-stage game involving two upstream firms, Ul and U2, and two downstream firms, Dl and D2. In the first stage, the downstream firms can bid to acquire Ul. If there is an acquisition, (say, Dl acquires Ul to form F1), upstream input prices are set in the second stage. In the third stage, knowing the input prices it faces, D2 can attempt to acquire U2. Finally, in the fourth stage, Dl and D2 compete 'a la Bertrand with differentiated products. In his comment, David Reiffen (1992) makes three distinct points. First, he notes that once Dl has acquired Ul, the equilibrium of the subsequent subgame depends critically on how upstream prices are set in the second stage. He argues that our results depend on the ability of Fl to commit to a high upstream price. This criticism previously has been made by Oliver Hart and Jean Tirole (1990). We show below that the results in OSS do not depend on the ability of Fl to commit. Instead, our main result stems from the fact that vertical integration changes the firm's incentives to engage in price-cutting in the input market. The notion that vertically integrated firms behave differently from unintegrated ones in supplying inputs to downstream rivals would strike a businessperson, if not an economist, as common sense.1 We show that there is theoretical merit to that common-sense view. Second, Reiffen argues that the game considered by OSS is similar to a game in which there is no vertical integration but, rather, where a nonintegrated Dl has a first-mover advantage in the downstream market. In such a game, Dl benefits from the ability to commit to the price that its Stackelberg leadership position gives it. Reiffen considers this to be additional evidence in support of the claim that OSS depends critically on Fl's ability to commit, not on vertical integration. We explain why the mechanism by which Dl is able to raise its profits in the sequential one-shot game considered by Reiffen is conceptually quite different from the mechanism by which Dl profits from vertical integration in OSS. Third, Reiffen argues that our results depend on there being only two upstream firms. This is correct in the symmetric Bertrand model analyzed. However, as we discuss below, our results do obtain as long as the upstream price is decreasing in the number of firms, as occurs in many oligopoly models, particularly when costs vary across firms. The next section summarizes the conceptual problems pertaining to upstream pricing. These problems are resolved in Section II by means of simple and natural price * Ordover: Department of Economics, New York University, 269 Mercer St., 7th Floor, New York, NY 10003; Saloner: Graduate School of Business, Stanford University, Stanford, CA 94305; Salop: Georgetown University Law Center, 600 New Jersey Avenue NW, Washington, DC 20001. We have benefited greatly from several discussions with Faruk Gul. Research support from the National Science Foundation (grant 8813943-IRI), the Sloan Foundation, and the C. V. Starr Center for Applied Economics at NYU is gratefully acknowledged. 'For example, the Japan-U.S. Strategic Impediments Initiative is predicated on the proposition that the loosely linked Japanese firms that form the various keiretsu do discriminate against nonaffiliated firms.

A model of product differentiation which combines elements of both spatial and representative consumer formulations is used to examine the properties of single- and multiple-price equilibria. Conditions under which decreases in the intensity of consumer preferences reduce price are given. It is shown that, with certain types of demand curves, entry can eliminate price-cost markups even given product differentiation. If competition is localized, it is demonstrated that entry does not affect the markup. Finally, the effect of spurious product differentiation on price is examined.