Informal input suppliers, quality choice and welfare

This paper proposes a theoretical model in which a formal upstream firm competes against informal input suppliers, which constitute an alternative, albeit lower-quality input source for formal downstream firms. The existence of an alternative source increases competition in the industry, which tends to be welfare-increasing. However, it may also distort the incentives of the formal upstream firm to invest in quality upgrading. Assuming quantity competition downstream, we analyze how these incentives change and whether the negative welfare effect of a reduced investment by the upstream firm may more than offset the positive welfare effect of increased competition brought about by informal input suppliers. We find that there are parameter values such that this is the case, and welfare decreases if informal input suppliers are present. We analyze the robustness of this result to alternative modeling assumptions, such as price competition downstream and the use of two-part tariffs by the formal upstream firm.

Price Versus Quantity Competition in a Vertically Related Market with Retailer’s Effort

Allowing downstream retailers to engage in demand-enhancing investment, this paper demonstrates that the classical conclusions regarding the comparison of Cournot and Bertrand competition in a vertically related market with decentralized bargaining are completely reversed. It shows that Bertrand competition is more efficient than Cournot competition, in the sense that both consumer surplus and social welfare are always higher in the former.