Working Paper: CEPR ID: DP17202
Authors: Mark Armstrong; John Vickers
Abstract: 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.
Keywords: multiproduct pricing; Edgeworth's paradox of taxation; cost passthrough; price discrimination; Ramsey pricing
JEL Codes: D42; H22; L12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in unit cost of one product (D24) | Decrease in prices for that product (D41) |
| Increase in unit cost of one product (D24) | Decrease in prices for other products (E39) |
| Increase in unit cost of one product (D24) | Increase in consumer surplus (D11) |