Refusal to Deal and Investment in Product Quality

Abstract

Purpose

This paper investigates the impact of refusal to deal by a monopoly supplier of an essential input on firms’ investments in product quality, consumer surplus, and net social welfare.

Methodology/approach

The paper uses a standard economic model of endogenous quality choice for horizontally differentiated products to compare market performance with and without refusal do deal.

Findings

Refusal to deal increases the payoff of the integrated firm and reduces equilibrium investment in quality, consumer surplus, and net social welfare if varieties are moderate or good substitutes. If varieties are poor substitutes, the integrated firm maximizes its payoff setting a wholesale price that allows the downstream rival a small economic profit.

Research/practical/social implications

The analysis presented here implies that it is actual rivalry in the development of high-quality substitute varieties that promotes consumer welfare, and that such rivalry is ill served by the exercise of market power in input markets and by the refusal of vertically integrated upstream firms to deal with their nonintegrated downstream rivals. Reliance on the lure of monopoly profit to get good market performance is misplaced.

Citation

Martin, S. (2015), "Refusal to Deal and Investment in Product Quality", Economic and Legal Issues in Competition, Intellectual Property, Bankruptcy, and the Cost of Raising Children (Research in Law and Economics, Vol. 27), Emerald Group Publishing Limited, Leeds, pp. 43-66. https://doi.org/10.1108/S0193-589520150000027002