Price Discrimination, Two-Part Tariff, and Hold-Up

Abstract

This study examines the impact of price discrimination on the investment decisions of downstream firms in an intermediate good market. The setting consists of two downstream firms with different marginal costs—one lower than the other—and a monopolistic supplier. The firms decide whether to invest in reducing their marginal costs, with investment costs becoming sunk after the decision. Once these costs are revealed, the supplier offers discriminatory two-part tariff contracts. Under discriminatory pricing, a unique equilibrium emerges in which the hold-up problem prevents any investment. However, prohibiting price discrimination mitigates this issue, enabling the more efficient downstream firm to invest in equilibrium. The ban on price discrimination has mixed effects on social welfare. We demonstrate that in some cases, the positive effects of the ban outweigh the negative ones, ultimately enhancing social welfare.