Favoritism in Vertical Relationship: Input Prices and Access Quality

Favoritism in vertical relationship is a situation in which an upstream firm sets favorable exchange conditions to some agents at the expense of others. This paper explores the reason for, and direction of, favoritism in the vertical relationship between an upstream firm and a number of downstream firms that are Cournot rivals relying on the inputs provided by the upstream firm. We show that favoritism may arise from profit maximization. We address the following questions: (i) if the upstream firm can charge different prices to different downstream firms, will it treat the less efficient firms more favorably? (ii) if the upstream firm can provide different levels of quality of access to several ex ante identical downstream firms, will it provide a uniform quality of access? We show that the answer to (i) depends on whether downstream firms can self-supply, and we characterize the structure of favors. As for (ii), we show that among ex-ante equal firms, some firms will be selected for favorable treatment.
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