The resale price maintenance policy dilemma: comment.

• Author: Boudreaux, Donald J.

1. Introduction

   The issue of quality valuation, especially as it relates to "imperfectly competitive" markets, has a long lineage in the history of economic theory. E. H. Chamberlin made the issue a central feature in his paradigm of monopolistic competition in 1933. More recently, the issue of quality has arisen with respect to monopoly [19] and, even closer in time, to the matter of the efficiency of vertical restraints, including resale price maintenance (RPM) and exclusive territories [7].

   In a recent contribution to this Journal, Roger D. Blair and James M. Fesmire (hereafter BF) [1] analyzed an alleged RPM policy dilemma created by product-quality changes made possible by vertical restraints. BF did so with respect to the effects that the introduction of price or non-price restraints might have on consumer (and consumer/producer) surplus. Using the Spence-Comanor argument concerning the possible existence of so-called inframarginal consumers (who do not value quality changes initiated by producers as much as do marginal consumers), BF show that RPM can cause welfare to decline. Thus the policy dilemma: Neither per se legality nor illegality of vertical restraints can be defended due to ambiguous effects of RPM on welfare. And worse, the rule of reason criterion on which decisions currently are based "appears to be unavailing as well due to measurement problems" [1, 1046].

   We have little quarrel with the formal analysis BF used to arrive at this unhappy conclusion. The purpose of this note is to explore the analysis and logic that undergirds the Spence-Comanor-BF notion of "inframarginal consumers." We show that vertical restraints should indeed be per se legal. The policy conundrum suggested by BF's analysis is less of a dilemma than they believe.

2. Vertical Restraints and Consumer Welfare

   The important issues and contributions to the theory of vertical restraints are adequately treated in BF and elsewhere [2]. A few considerations are key for the present investigation. In Bork's view "consumer choice will dictate the use or non-use of r.p.m. When r.p.m. is the more profitable course for the manufacturer of product x, we know that consumers as a whole prefer product x with the reseller-provided information and service that is purchased by r.p.m.... The consideration of consumer choice supports the proposal to legalize manufacturer r.p.m." [3; 4, 742-43]. Many explanations of the kinds of quality improvements that might accompany RPM followed [13; 14; 11].(1)

   Others demurred from the "efficiency rationale," chief among them Comanor [7] and Comanor and Kirkwood [8]. Building on Spence's analysis of product quality and monopoly, Comanor argued against per se legality of RPM on grounds that the economic welfare of inframarginal consumers may be substantially damaged by the development and introduction of new product qualities through vertical restraints. Specifically, Comanor claims to have identified particular "circumstances in which manufacturers' interests conflict with those of consumers" [7, 983]. According to this argument, important differences among consumers have been ignored by those who endorse per se legality of vertical restraints. Only so-called marginal consumers affect sellers' policies in Comanor's view, but the net welfare outcome is determined by all consumers, marginal and inframarginal. When a significant number of inframarginal consumers attach little or no value to new dealer services introduced through vertical restraints, inframarginal consumers pay higher prices for goods that are of no higher value to them. The welfare gains to marginal consumers may be offset, or more than offset, by the loss inflicted upon inframarginal consumers. Comanor also argues that price and non-price vertical restraints judged by a rule of reason make more sense for "new products or products of new entrants into the market" than for established products. For the latter he advocates per se illegality, or a rule of reason in which the defendant bears the burden of proving that the change in net welfare is positive [7, 1001-2]. BF cogently summarize this argument [1, 1045].

3. Analytical Weaknesses in the "Inframarginal" Rationale

   BF's argument raises some fundamental theoretical questions concerning the how and why of the different consumer valuations.(2) Comanor simply argues that "If the amount that a marginal consumer is willing to pay for higher quality even slightly exceeds the accompanying increase in price, he will generally buy more of the product. Similarly, if he does not find the improvements worth the increased price, he will generally purchase less" [7, 991]. Inframarginal consumers, who are "relatively insensitive to any price increase needed to fund a change in product quality," appear to be virtually unmoved. According to Comanor, "Even if, according to their valuations, the improvement does not warrant the additional cost, they will not buy less of the product as a result" [7, 991]. Marginal consumers alone consume marginally here and determine profitability to manufacturers, but inframarginal consumers are not allowed (by assumption) to consume marginally, thus creating the ambiguous welfare effects of vertical restraints. This is, in effect, similar to an externality argument with respect to vertical restraints.(3) The introduction of quality changes is independent of the overall welfare changes in the market.(4) Any quality change, inspired by RPM or not, would be subject to the externality.

   There are clear limitations to the argument concerning the behavior of inframarginal consumers. While superficially plausible, the argument does not stand up well to even a reasonable amount of scrutiny. Consider Figures 1(a) and 1(b) as regards inframarginal consumer behavior.(5) In Figure 1(a) a "Dupuit-Stigler" theory of quality-adjusted demand is shown. Product quality is held constant along any specific demand curve. A new quality dimension would (ordinarily) increase the marginal evaluations of consumers and the negative slope simply...