Academic journal article Economic Inquiry

Transaction Cost, Two-Part Tariffs, and Collusion

Academic journal article Economic Inquiry

Transaction Cost, Two-Part Tariffs, and Collusion

Article excerpt


This paper studies a situation in which cartelization serves to reduce prices and improve social welfare. The unusual outcome can be attributed to demand complementarity that exists between the goods under consideration. Because market demand functions exhibit such complementarity, a reduction in either seller's price raises the demand for the other seller's product. A cartel internalizes this cross-effect and sets prices at relatively low levels, whereas the same firms acting as rivals ignore the interdependence and set prices somewhat higher. The complementarity originates from transaction costs that customers pay in order to participate in exchange; hence, complementarity exhibits a specific mathematical form in market demand functions. One could even adopt the view that these transaction costs are the underlying circumstance that makes collusion socially more attractive than rivalry.

Another feature that must be mentioned is firms' use of "two-part tariffs." Under this pricing scheme the customer pays a seller an entrance fee to obtain the privilege of purchasing merchandise, then also pays a per-unit price on merchandise actually obtained. In the context of two-part tariffs, the paper's main finding can be stated as follows: The sum of entrance fees facing customers is smaller when sellers form a cartel than when they set prices independently; however, per-unit prices are the same whether sellers collude or not.

This model with transaction costs appropriately describes a geographical marketplace, such as a shopping mall or central business district, in which potential customers face expenses for transportation. Within the centralized shopping area, a department store assesses customers an annual fee for the privilege of shopping (this is the store's entrance fee) in addition to per-unit prices on merchandise. A health spa next door imposes membership dues and pay-as-you-go fees on its services. A theater sells passes (another type of entrance fee) that entitle holders to special rates on movies attended later. A similar situation is tourism, in which case the tourist encounters expenses when traveling to a vacation or convention site. At this location hotels charge a daily entrance fee for lodging plus something additional for each meal and telephone call. Rental cars are available for a fixed charge plus an added price per mile driven. Entertainment (e.g., Disneyland) might be marketed through a two-part tariff as well.

A different sort of transaction cost is the expense of educating oneself before being able to effectively utilize certain goods and services. Speculating in the stock market, say, requires prior study of finance and IRS rules. After paying this initial transaction cost, the ready investor encounters two-part tariffs through which related services are sold. Entrance fees might take several forms: a stock broker levies an annual maintenance charge on accounts; an advisory service's newsletter is available at a fixed subscription rate; a mutual fund charges new shareholders a roughly constant "load". It is argued below that these entrance fees would all be lower if the vendors formed a cartel.

Two-part tariffs have been studied in this journal before. Murphy [1977] computes a monopolistic seller's profit-maximizing, multi-part tariff. Although the seller cannot discriminate between rich and poor customers ex ante, self-sorting occurs if the seller designs the correct price schedule. Scott and Morrell [1985] investigate a two-good monopoly that employs two-part tariffs. If one good's entrance fee must be set equal to zero (for exogenous reasons), then optimal values of the remaining price parameters hinge on the exact nature of demand interdependence. Strong results are obtained when customers are identical. Levin [1988] compares the Stackelberg, Nash, and collusive behavior of firms that employ ordinary pricing. In another journal, Stahl [1982] analyzes rivalry and collusion when buyers pay transportation costs and vendors use ordinary linear pricing. …

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