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Countervailing Power and Input Pricing: When is a Waterbed Effect Likely?

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  • Stephen P. King

Abstract

A downstream firm with countervailing power can extract a reduced price from an input supplier. A waterbed effect occurs if this price reduction leads the input supplier to raise the price that it charges another downstream firm. Policy makers have been concerned that this waterbed effect could undermine downstream competition and it was considered in detail in the 2008 UK grocery inquiry. This paper presents a simple but parsimonious model to investigate if and when a waterbed effect may arise. It shows that the effect may arise through optimal pricing behaviour, but that this critically depends on the nature of upstream technology, downstream competition and consumer demand. In particular, downstream competition tends to work against a waterbed effect, but convex upstream costs support the effect. The analysis is complementary to recent academic work on the waterbed effect that focuses on bargaining constraints .

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  • Stephen P. King, 2013. "Countervailing Power and Input Pricing: When is a Waterbed Effect Likely?," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 20(3), pages 325-340, November.
    • Handle: RePEc:taf:ijecbs:v:20:y:2013:i:3:p:325-340
    DOI: 10.1080/13571516.2013.835982
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    4. Adrian Majumdar, 2005. "Waterbed Effects and Buyer Mergers," Working Paper series, University of East Anglia, Centre for Competition Policy (CCP) 2005-07, Centre for Competition Policy, University of East Anglia, Norwich, UK..
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