Input price discrimination with differentiated final products

This paper examines the welfare effects of third-degree price discrimination by an input monopolist when downstream producers compete with differentiated goods and consumers have heterogeneous preferences for the products. The input monopolist's optimal pricing follows the standard inverse-elasticity rule, but its implication for welfare differs from the traditional analysis with homogeneous goods. Price discrimination can improve welfare even without an increase in total output or opening of new market. Also, the effect of price discrimination on consumer surplus differs from the one obtained for the case of price discrimination in final-goods markets. Our results shed new light on public policy regarding input price discrimination. We can no longer claim that price discrimination is harmful to society because it does not increase or reduces total output. Moreover, different policy responses are required depending on welfare standard. Simple policy guidelines are proposed that can be used in actual antitrust cases.