Product Variety and Welfare under Discriminatory and Mill Pricing Policies

We re-examine the economic justification for the regulation of firms' spatial price policies. Existing analysis, by treating market structure as exogenous, loses an important trade-off. Discriminatory pricing is more competitive between incumbents but acts as a strong deterrent against entry. Product variety is determined by the degree of spatial contestability of the market (the ability of entrants to make binding location commitments) and by whether firms can price discriminate. The entry deterring effect of discriminatory pricing is dominant whatever the degree of spatial contestability or the nature of demand but welfare effects depend upon the degree of spatial contestability. The lower the degree of spatial contestability, the more effective is discriminatory pricing at limiting entry and the more likely is it that mill pricing is socially desirable.