The Law and Economics of Non-Exclusionary Price Floors

Abstract

This paper integrates two separate branches of the law and economics literature to demonstrate the two-sided risk of market exclusion by a vertically-integrated firm (VIF) with upstream and downstream market power. The ratio of downstream (retail) to upstream (wholesale) price margins is key to the analysis. A margin ratio that is “too low” can result in a vertical price squeeze. This occurs when a relatively efficient rival cannot secure the bottleneck input at a price that enables it to compete in the downstream market. A margin ratio that is “too high” creates incentives for the VIF to engage in non-price discrimination (sabotage). By raising its rivals’ costs, and in turn it downstream price, the VIF can divert demand from its rivals to itself. Displacement ratios delineate the range of safe harbor margin ratios within which neither form of market exclusion arises. The admissible range of these margin ratios is decreasing in the degree of product substitutability and reduces to a single ratio in the limit as the competing products become perfect substitutes. The challenge for policymakers is to apply these pricing constraints judiciously to prevent market exclusion in accordance with a consumer-welfare standard, while recognizing the risk that these protections can be appropriated and used strategically in the errant pursuit of a competitor-welfare standard.