Two retail firms compete in prices (Bertrand competition with non-di erentiated goods) in a downstream market in which base demand is given by Pr = 1-Q. The rms can provide service si 2 f0; 1g in order to augment demand (e.g., they can explain all the features of the good for sale). However, such service is non-appropriable in that it cannot be conditioned on a customer making a purchase. As a result, service is in e ect a public good. Spefi cally, suppose that if the rms o er service levels of s1 2 f0; 1g and s2 2 f0; 1g, demand is Pr = 1 + max(s1; s2) - Q. Suppose further that if rms charge the same price, customers will randomly choose to buy at a rm that provided service (if both provide service or if neither provide service the market is split evenly). The cost of providing service is c(s) =:1 if s = 1; 0 if s = 0:
The only other cost that the retailers have is the wholesale price Pw for the good. Suppose that this price is set by an upstream wholesaler with monopoly pricing power.
1. If the wholesaler can only set the wholesale price Pw and then simply sells to the retailers whatever they demand, what is the equilibrium wholesale price, Pw, the equilibrium level of service provision s1; s2 and the equilibrium retail price Pr?
2. Suppose that the wholesaler can impose retail price maintenance that commits the downstream retailers to charge a minimum price Pmin. Given this option, what is the equilibrium minimum price Pmin, the equilibrium wholesale price, Pw, the equilibrium level of service provision s1; s2 and the equilibrium retail price Pr?