Wholesale Price Discrimination: Innovation Incentives and Upstream Competition
In intermediate good markets where there are alternative supply sources, wholesale price discrimination may enhance innovation incentives downstream. We consider a vertical chain where a dominant firm and a competitive fringe supply imperfect substitutes to duopoly retailers which carry both varieties. We show that a ban on price discrimination by the dominant supplier makes uniform pricing credible and reduces retailers&#8217; incentives to decrease the cost of acquiring the competitively supplied variety, leading to higher upstream profits and lower downstream welfare. Our analysis complements existing results by identifying a novel channel through which wholesale price discrimination can improve dynamic market efficiency.