Market power, price discrimination, and allocative efficiency in intermediate-goods markets

We consider a monopolistic supplier's optimal choice of two-part tariff contracts when downstream firms are asymmetric. We find that the optimal discriminatory contracts amplify differences in downstream firms' competitiveness. Firms that are larger-either because they are more efficient or because they sell a superior product-obtain a lower wholesale price than their rivals. This increases allocative efficiency by favoring the more productive firms. In contrast, we show that a ban on price discrimination reduces allocative efficiency and can lead to higher wholesale prices for all firms. As a result, consumer surplus, industry profits, and welfare are lower.