A Model of Vertical Restriction and Equilibrium in Retailing

Abstract

One sort of economic behavior that continues to engage the attention of economists is the imposition by some manufacturers of restrictions on their wholesalers and retailers. Why would manufacturers want to impose minimum retail prices, and why would they want to control the locations at which their goods are distributed to consumers? An application of simple economic principles suggests that manufacturers with a monopoly in a product-this could be a monopoly achieved through patents, for exampleshould charge the profit-maximizing wholesale price and let retailers fend for themselves. And if more stores want to carry the product, so much the better, because this increases the likelihood that consumers will run across it. A widely accepted explanation for the desire of manufacturers to be able to stipulate resale prices is based on the possibility that manufacturers of branded goods often want retailers to provide some joint service that cannot easily be charged for. The clearest example is sales or promotional effort. The effect of a minimum retail price in these cases is to establish an incentive to provide jointly supplied services that no individual retailer would otherwise provide. This model of distribution provides a rationale for restrictions placed on retailers by manufacturers. The manufacturer's customers are located uniformly along a road, and retailing operations are subject to increasing returns. Three difficulties arise. First, retailers acting in concert can earn positive profits at the expense of the manufacturer and consumers. Second, costless relocation, free entry, and competition will not result in the store density and retail price favored by the manufacturer. Third, store locations fixed in the short run imply that price cutting would undermine the density of stores preferred by the manufacturer.