DP17202 Multiproduct Cost Passthrough: Edgeworth's Paradox Revisited

Author(s): Mark Armstrong, John Vickers
Publication Date: April 2022
Keyword(s): cost passthrough, Edgeworth's paradox of taxation, Multiproduct pricing, price discrimination, Ramsey pricing
JEL(s): D42, H22, L12
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17202

Edgeworth's paradox of taxation occurs when an increase in the unit cost of a product causes a multiproduct monopolist to reduce prices. We give simple illustrations of the paradox, including how it can arise with uniform pricing. We then give a general analysis of the case of linear marginal cost and demand conditions, showing how the matrix of cost passthrough terms is similar to a positive definite matrix, and so has positive eigenvalues. When the firm supplies two substitute products we show how Edgeworth's paradox always occurs with a suitable choice of cost function. We then establish a connection between Ramsey pricing and the paradox in a form relating to consumer surplus, and use it to find further examples where consumer surplus increases with cost.