Tying, Price Discrimination and Antitrust Policy

Herbert Hovenkamp, University of Iowa

Abstract

ABSTRACT

A tying arrangement is a seller’s requirement that a customer may purchase its “tying” product only by taking its “tied” product. In a variable proportion tie the purchaser can vary her purchases of the tied product. For example, a customer might purchase a single printer, but either a contract or technological design requires her to purchase varying numbers of printer cartridges from the same manufacturer. Such arrangements are widely considered to be price discrimination devices, but their economic effects have been controversial.

Price discrimination comes in various “degrees.” In third degree price discrimination the seller isolates two or more different sets of customers who have differential willingness-to-pay and charges them different prices. This practice creates a discontinuity in marginal valuation which entails that some output is assigned from higher value to lower value purchasers. As a result, any third degree price discrimination scheme that fails to increase output will reduce economic welfare.

By contrast, second degree price discrimination occurs when a firm creates a price schedule and customers determine where on the schedule they purchase. Common examples are quantity discounts or differential pricing for different classes of transportation. In these cases, which include variable proportion ties, there is no discontinuity in marginal valuation. For example, in a tie every buyer purchases up to the point that her marginal valuation of the tied product equals its price, and that price is the same for everyone. Such arrangements can improve welfare and benefit consumers even if output falls, and are likely to benefit consumers when output increases. We conclude that variable proportion ties very likely increase both total welfare (producer surplus plus consumer surplus) and consumer welfare (consumer surplus alone).

The case for variable proportion ties becomes even stronger when one considers fixed costs and scale economies, which reward higher output with lower costs. Variable proportion ties can also deconcentrate downstream markets, benefitting consumers. Finally, tying often reflects economies of joint provision or improved quality of product or distribution.

The policy implication is that antitrust law should forget about price discrimination as an independent anticompetitive concern. The one measurable exception occurs when the tie benefits no one other than the seller. Even the noneconomic rationale for condemnation that price discrimination is an unappealing practice disappears once we consider that the true impact of variable proportion ties is to reduce rather than increase the extent of price disparities to buyers.