Pricing Access to a Monopoly Input

Abstract

What price should entrants pay an incumbent monopoly for use of its assets? Courts, legislators, and regulators have at times mandated that incumbent monopolies lease assets required for the production of a retail service to entrants in efforts to increase the competitiveness of retail markets. This paper compares two rules for pricing such monopoly inputs: marginal cost pricing (MCP) and Generalized Efficient Component Pricing Rule (GECPR). The GECPR is not a fixed price, but is a rule that determines the input price from the entrant's retail price. Comparing the retail market equilibrium under MCP and GECPR, the GECPR equals or dominates MCP in terms of allocative efficiency. If the incumbent is less efficient that the entrant, the GECPR also dominates MCP in allocative efficiency. If the incumbent is more efficient than the entrant, however, conditions may exist in which MCP leads to lower production costs than does the MECPR, so that the total surplus may be higher under MCP. The analysis is carried out assuming either Bertrand competition, quantity competition or monopolistic competition between the incumbent and entrant.