Vertical Relations

Vertical relations describes a supply chain where a producer (upstream monopolist) sells to a retailer (downstream monopolist), each of which marks up price above its own marginal cost. When both stages independently maximise profit, the retailer treats the wholesale price as its cost and marks up again — double marginalisation — producing a final consumer price higher and a final quantity lower than if the two stages were integrated into one firm.

For market demand $P = A - Q$ and producer $MC = k$, the vertical chain yields $Q^{VR} = (A-k)/4$ and $P^{VR} = (3A+k)/4$, while an integrated monopolist would set $Q^M = (A-k)/2$ and $P^M = (A+k)/2$. The chain produces only half the efficient monopoly output. The welfare ordering is: perfect competition $\succ$ integrated monopoly $\succ$ vertical chain. Remedies include vertical integration, a two-part wholesale tariff, or resale price maintenance — all of which collapse the chain back to the integrated monopoly outcome. See Topic 2 — Equilibrium in Different Market Structures.

When to use

Apply the vertical-relations framework whenever a supply chain involves sequential monopoly pricing — each stage extracts margin without internalising the demand it destroys for the downstream stage. The key insight is that the chain is worse than a single integrated monopolist both for consumers and for industry profit combined, giving both sides a motive to negotiate contracts that eliminate the second markup.