THE INCENTIVES FOR RESALE PRICE MAINTENANCE UNDER IMPERFECT INFORMATION

Abstract

This paper considers both the incentives for and the welfare effects of resale price maintenance (RPM) in retail markets characterized by imperfect consumer information. In markets where point‐of‐sale information on the product is essential for sales and information on prices is costly, RPM permits manufacturers with some monopoly power to resolve two incentive conflicts with retailers. First, because retailers with price‐setting powers do not appropriate the gains in profit to an upstream manufacturer from actions taken to increase demand, their incentives to inform consumers of the product and to set low prices are inadequate. This purely vertical externality results in the classic “double mark‐up” of final prices. Second, when consumers' costs of price search vary, stores offering low prices and no information can exist in the market equilibrium. These discount houses free‐ride on the informational services of high‐price informing retail outlets — a horizontal externality. In the imperfect information setting of this paper, (1) administered pricing improves monopolists' profits by resolving the incentive conflict; (2) the profitable use of a price floor reduces the maximum retail price charged and may reduce the average retail price; (3) price floors or administered prices can be Pareto‐improving and more likely welfare (surplus)‐improving; (4) price floors are welfare‐improving.