A Signal Jamming Theory of Resale Price Maintenance
34 Pages Posted: 25 Apr 2003
Date Written: May 2003
This paper contains a theoretical analysis demonstrating that a retail price floor can increase the expected profits of an upstream firm when it is asymmetrically informed about the state of product demand. The retail price floor serves to eliminate the incentives of the upstream firm to misrepresent its private information and, thus, reduces the transaction costs associated with the strategic use of information. The wholesale and retail prices (and profits) that emerge in the equilibrium with the asymmetrically informed upstream firm given a retail price floor are identical to those that obtain when prices reflect only common prior knowledge about the state of demand. In this way, the retail price floor serves to jam or block the transmission of the upstream firm's private knowledge and increase, for some parameter values, its profits. When used for this purpose, the retail price floor reduces social welfare and lowers the expected retail margin, an observed empirical regularity.
Keywords: Industrial Organization, Vertical Restraints, Resale Price Maintenance
JEL Classification: L1, L2, L4, L15, L22, L42
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