Question

3. Discuss the problem of double marginalization. What is it? What causes it? How is it mitigated by a vertical merger?

Answer 1

Double Marginalization

Double Marginalization is defined as the "excercise of market power at successive vertical layers in a supply chain". It is the phenomenon in which different firms in the same industry that have their respective market powers but at different vertical levels in the supply chain apply their own markups in prices.

Due to these markups individually a deadweight loss is induced and because of both the markups the deadweight loss occurs twice thus making it worse off for the whole market due to double marginalization.

One way of mitigating the losses cause by double marginalization is through vertical integration of the two firms in the supply chain which lead to reduction of at least one of the dead weight losses.