The effects of resale-below-cost laws in the presence of a strategic manufacturer
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In retail markets, below-cost (or loss-leader) pricing is an important marketing tool to attract customers. However, several countries have adopted resale-below-cost laws that ban retailers from adopting this promotion strategy. In this study, we theoretically investigate how banning below-cost pricing influences equilibrium prices, firms’ profits, and consumer surplus. We explicitly consider not only horizontal competition between retailers but also vertical channel relationships between manufacturers and retailers. In addition, we focus on asymmetric competition between dominant and weak retailers, which have heterogeneous bargaining positions vis-à-vis an upstream manufacturer. We show that this ban induces the manufacturer to reduce its wholesale price and can lead to a decrease in equilibrium retail prices including that of a loss-leader product. We also show that owing to the effects of such price reductions, the ban always improves the total consumer surplus and can benefit the weak retailer in terms of bargaining position, although it always harms the manufacturer and the dominant retailer.
KeywordsBelow-cost pricing Channel power Resale-below-cost laws Vertical relations
JEL ClassificationL13 L41 M38 D21
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