This paper investigates the marketing of a primary commodity produced by competitive producers that sell to a single upstream processor. There is a significant lag between production and marketing decisions made by producers. If a credible price commitment cannot be made before producers make their output decision, it is a dominant strategy for the processor to buy producers’ output at the world price adjusted for transportation costs. Producers fully anticipate this partial hold-up ex-ante and adjust production accordingly. When the processor’s capacity is binding ex-post, the equilibrium is described as a low-price low-capacity trap. Under a specific condition, the processor finds it advantageous to credibly commit to a price increment before producers make their output decision. The ensuing equilibrium is Pareto superior to the no-commitment equilibrium. We argue that the Quebec hog/pork industry has experienced such a situation in the last few years. Government intervention is justified even if the processor has committed to a price increment. The modeling of strategic interactions between the government and the processor reveals that their price increments are strategic substitutes. However, given that the processor’s (government’s) payoff is increasing with the government’s (processor’s) price increment, the first-mover advantage entails committing early to a low price increment to force one’s rival to offer a high price increment.
- vertical coordination,
- price commitment.
Available at: http://works.bepress.com/jp_gervais/7/