Oligopolistic competition often requires a costly infrastructure to build and costly transportation on it. This can vary from costs of postal services when purchasing books or computers from online shops to physical infrastructure required to transportation of water, chemicals, electricity and natural gas. Also, registered membership by customers or suppliers providing parts of newly developed airplanes, vehicles or add-ins for software often involve development costs to meet the builder’s desired specifications. In such contexts, payments for commodities consist of a price per unit and a fee, i.e. a fixed monetary amount. Transportation costs may differ per supplier and per customer, for example tariffs for postal services typically distinguish between domestic and foreign destinations.
The importance of heterogeneous transportation costs in trade is not at par with standard microeconomics, with the notable exceptions of Hotelling (1929), and Salop (1979) for commodity markets with infinitely many small customers. Also, oligopolistic competition in both prices and fees receives limited attention, except e.g. Oi (1971), Schmalensee (1981) and Schmalensee (1982) for monopoly markets where the supplier lacks information about the consumers’willingness to pay. In this paper, we analyze competition in both prices and fees in an oligopolistic market with a finite number of heterogeneous buyers. We also take into account heterogeneous costs for production and transportation combined with costly infrastructure to build. The aim of this paper, is to analyze oligopolistic competition and market power in such markets with exogenous and endogenous infrastructure.
We study a market with costly infrastructure, a few concentrated producers who possess market power, and a few concentrated buyers who can exercise buyer power. This trade structure, referred to as bilateral oligopoly, characterizes many markets, such as natural resources or postal services, and markets for intermediate goods as discussed in e.g. Bjornerstedt and Stenneck (2007). It is well known that supplier side concentration and market power have negative consequences for consumer welfare and total social welfare, see e.g. Tirole (1988) Tirole (1988) or Motta (2004). However, especially in bilateral oligopoly with high concentration on both sides, the relationship between concentration, market power and effi ciency is much more complex, and little work has tried to understand this relationship both theoretically and empirically. It should be stressed that the ability of a firm to charge high prices also depends on the degree of concentration of the buyers. A firm is clearly more free to exert market power if it faces a large number of dispersed consumers or buyers than if it faces one or a few strong buyers.
Galbraith (1952) is probably the first author who has argued that countervailing power of buyers can considerably restrain the market power of sellers. Several empirical works have tried to test the countervailing power hypothesis, and there appears to be some evidence that buyer concentration does negatively affect the market power of the sellers. See Scherer and Ross (1990) for a review of this literature, initiated by Lustgarten (1975). Among more recent works, Schumacher (1991) also supports the countervailing power hypothesis in a study based on US manufacturing industries. To be more precise, a strong buyer can make use of its bargaining power to stimulate competition among sellers, either by threatening to switch orders from one seller to another, or by threatening to start upstream production itself. Scherer and Ross (1990) point out two possibilities discussed above. In this paper we develop a theoretical model of competition on an infrastructure that incorporates the possibility to switch between suppliers and show that the resulting market outcome is stable, effi cient, and it provides the maximal protection from the supply side’s market power.
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Market Power in Markets with Price-Fee Competition and Costly Infrastructure
