The Law and Economics of Nonexclusionary Price Floors

This chapter integrates two separate branches of the law and economics literature to demonstrate the two-sided risk of market exclusion by a vertically integrated firm (VIF) with upstream and downstream market power. The ratio of downstream (retail) to upstream (wholesale) price-cost margins is key. A margin ratio that is “too low” can result in a vertical price squeeze, whereas one that is “too high” can create incentives for the VIF to engage in non-price discrimination or sabotage. A price squeeze occurs when a rival is inefficiently foreclosed because the upstream (input) price is too high relative to the downstream (output) price. Sabotage arises when the VIF raises its rivals' costs which, in turn, raises their prices and diverts demand from the rivals to the VIF. Displacement ratios delineate the range of safe harbor margin ratios within which neither form of market exclusion arises. The admissible range of these margin ratios is decreasing in the degree of product substitutability and reduces to a single ratio in the limit as the competing products approach perfect substitutes. The policy challenge is to apply these pricing constraints judiciously to prevent market exclusion in accordance with a consumer-welfare standard, while recognizing the risk that these protections can be appropriated and used strategically in the errant pursuit of a competitor-welfare standard. These issues may take on greater prominence in light of the recent release of the DOJ/FTC draft vertical merger guidelines.