Double Marginalization Problem

Double Marginalization is the phenomenon in which different firms in the same industry that have their respective market powers but at different vertical levels in the supply chain apply their own markups in prices. Recall that the pricing over marginal cost (MC) yields deadweight losses.

Due to these markups individually a deadweight loss is induced and because of both the markups the deadweight loss occurs twice thus making it worse off for the whole market due to double marginalization.

For example, in a case of two independent firms, one upstream and one downstream in a supply chain, with respective market powers, the deadweight losses will be incurred twice. One way of avoiding the losses due to double marginalization is by integrating the two firms vertically and thus reducing at least one of the dead weight losses. This can be done through merger and acquisition of one of the firm by the other firm in the supply chain.