Input-Quality Sabotage and the Welfare Consequences of Parity Rules

33 Pages Posted: 20 Jan 2007

See all articles by James D. Reitzes

James D. Reitzes

The Brattle Group

Glenn Woroch

University of California, Berkeley; Compass Lexecon; Georgetown Center for Business & Public Policy

Multiple version iconThere are 2 versions of this paper

Date Written: January 2007

Abstract

We analyze the welfare effects of parity rules, prevalent in telecommunications and other regulated industries, that force a vertically-integrated input monopolist to treat its own downstream affiliate and downstream competitors comparably in terms of input price and quality. When input pricing is unconstrained, our results show that input-quality parity requirements may lower social welfare. Either no private incentive exists to engage in input-quality discrimination, or the presence of rival input-quality sabotage (or possibly self-sabotage) is both a profit-maximizing and welfare-maximizing outcome. With cost-based input-pricing parity requirements, the input monopolist has incentive to inefficiently downgrade its downstream rival's input quality and possibly to excessively upgrade the input quality of its downstream affiliate. Thus, the desirability of input-quality parity requirements is highly dependent on the nature of the input-pricing policy. We also find that input-quality parity not only creates an incentive for the input monopolist to set a higher input price to its downstream rivals, but to set price above marginal cost to its downstream affiliate as well.

Keywords: sabotage, quality discrimination, price discrimination, random-utility model, bottleneck monopoly

JEL Classification: L12, L13, L22, L40, L43, L51, L96

Suggested Citation

Reitzes, James D. and Woroch, Glenn, Input-Quality Sabotage and the Welfare Consequences of Parity Rules (January 2007). Available at SSRN: https://ssrn.com/abstract=957564 or http://dx.doi.org/10.2139/ssrn.957564

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