Welfare, Output Allocation and Price Discrimination in Input Markets

We analyze the price decision of an upstream monopolist who produces and sells an intermediate good to downstream markets where a backward-integrated chain store competes with many local retailers. It is shown that the upstream monopolist may charge a more efficient local retailer a lower input price under price discrimination. This finding is of interest as it goes against the standard conclusion in the input price discrimination literature. Moreover, contrary to the general findings in the literature in which input price discrimination is welfare-deteriorating, we find that input price discrimination improves social welfare if the positive output allocation efficiency effect outweighs the negative production efficiency effect. These results are robust even if the chain store is not backward integrated.