Double Marginalization

Article by Sam Mishra, MBA (MIT Sloan)

Double marginalization happens when there is market power at two channel segments. This produces a double whammy effect of lower total channel profits, and higher retail prices.

For example, let’s take a simple channel with two segments: manufacturer, and retailer. If both the retailer and manufacturer are monopolists, there is market power in both the segments of the channel. This is a simple case of double marginalization. which results in lower total channel profits, and higher retail prices.

In a simple example of double marginalization below, it is illustrated that if market power exists in both the segments of a two layer channel, the end consumer pays a higher retail price of $10.70 as opposed to $ 7.13 in case of no double marginalization (only the manufacturer has market power, and not the retailer). Further, it is illustrated that in case of double marginalization, the total channel profits of $ 6625.36 are lower compared to the profits of $ 8838.76 in case of no double marginalization.

I. No double marginalization: only the Manufacturer has Monopoly Power

Let us assume the demand curve is:

Q_D= 2480 – 174P

Let’s assume the monopoly price demanded by the Manufacturer is P_M. Assuming that the retail channel has perfect competition, using the profit maximization formula MR = MC, we get the retail price as:

P = MR = MC = P_M

Where MR = Marginal Revenue

MC = Marginal Cost

So, profit of the manufacturer is given by:

∏ = Q_D* P_M

= (2480 – 174 P) * P_M

= 2480 P_M – 174 (P_M)²

So, profit is maximized at:

∂∏ ∕ ∂P_M = 2480 – 2 * 174 * P_M = 0

or 2480 = 348 P_M

or P_M = 2480 / 348 = $ 7.13

Since the retailers make no profits, all profits are retained by the monopolist manufacturer, and the total channel profits are

∏ = 2480 P_M – 174 (P_M)²

= 2480 * 7.13 – 174 * (7.13)²

= 17682.4 - 8845.62

= $ 8838.76

Continued on Double Marginalization Part II