UPSTREAM CAPACITY CONSTRAINT AND THE PRESERVATION OF MONOPOLY POWER IN PRIVATE BILATERAL CONTRACTING

This article presents a model of private vertical contracting with a capacity constrained monopolistic supplier. I consider 'full capacity beliefs' that are consistent with an upstream capacity constraint and are 'wary' when the constraint is tight or production is costless. I show that, facing a capacity constraint, the supplier may preserve its monopoly power in equilibrium. This result stands in sharp contrast to the standard result that the supplier cannot preserve its monopoly power, which holds under the usual implicit assumption of an infinite production capacity.