Should Resale Price Maintenance Be Legal?

If economists generally agree about anything, it is that competitively set prices maximize efficiency and welfare. On the other hand, another central tenet of economics is that efficiency may be achieved by allowing individuals and firms to enter into contracts with one another: for example, Ronald Coase famously showed that problems involving externalities could be solved if all affected parties could negotiate with one another.

However, not all contracts are legal. Most prominently, laws like the Sherman Antitrust Act place strict prohibitions on the kinds of contracts firms can write with one another. For example, airlines cannot agree with one another to keep prices high; that would be illegal collusion. Furthermore, manufacturers cannot require retailers to sell their products at a minimum price—a practice called "resale price maintenance."

The logic behind the banning of resale price maintenance is that the practice raises prices, and therefore decreases consumer welfare. This week, the ban came under attack as a leather-goods manufacturer argued before the Supreme Court that it should be allowed to dictate prices to retail outlets. Justice Antonin Scalia agreed, saying:

...the mere fact that [resale price maintenance] would increase prices doesn't prove anything. If in fact it's giving the consumer a choice of more service at a somewhat higher price, that would enhance consumer welfare, so long as there are competitive products at a lower price.

Recall that consumer surplus is defined by economists as the difference between what a consumer is willing to pay and the price they actually pay. One way of summarizing Justice Scalia's argument is that there are two variables in determining consumer surplus: the price, and the value of the service. If resale price maintenance encourages retail outlets to compete on service, the value to consumers may increase, and may increase more than the increase in price.

The key to this argument is the phrase "so long as there are competitive products at a lower price." In the case of the leather-goods market, it's true that there are lots of producers of leather goods. Therefore, high prices can only be sustained if there is an accompanying increase in quality of service.

Discussion Questions

1. Resale price maintenance agreements would seem to be good for retailers, as they allow them to sell at a price above marginal cost. Yet the plaintiff in this lawsuit was in fact the retailer, Kay's Kloset, who wanted to sell the leather goods made by Leegin Creative Leather Products at a discount. Who do you think benefits more from resale price maintenance agreements, manufacturers or retailers? Why?

2. On his blog, Greg Mankiw reprints the excellent summary from his textbook of the arguments for and against resale price maintenance. One argument for resale price maintenance is that it solves a free-rider problem that would otherwise prevent stores from offering good service:

[A manufacturer] may want its retailers to provide customers a pleasant showroom and a knowledgeable sales force. Yet, without resale price maintenance, some customers would take advantage of one store's service to learn about [a product's] features and then buy the item at a discount retailer that does not provide this service.

Do you think that resale price maintenance solves an important free-rider problem, as Mankiw suggests? Why or why not?

3. Resale price maintenance contracts are just one example of a kind of economic contract that is illegal. Philosophically, one might argue that it is illegal precisely because it limits the kind of contracts that one of the parties entering the contract can sign. For example, a resale price maintenance agreement that fixes the price of a leather jacket at $200 essentially stipulates that the retailer cannot enter into a contract with a buyer at which the jacket is sold for less than $200. Can you think of other contracts that people enter into that inhibit their ability to act freely in the future? Are they useful? Are they illegal? Should they be?

4. Some things are "per se" illegal under the Sherman Act, while for others, the "rule of reason" applies—that is, courts judge how anticompetitive they are on a case-by-case basis. If the leather-goods manufacturer is successful in this petition, resale price maintenance contracts would shift from the former category to the latter. Is that appropriate? How would you apply the "rule of reason" to a resale price maintenance case?

Organic, Fair-Trade, and Local Foods

According to the Associated Food and Petroleum Dealers, a traditional Thanksgiving dinner for 10 can cost as little as $36.70, or $3.67 per person. For some UC Berkeley students, celebrating Thanksgiving means paying a lot more--but buying food that is sustainable, organic, local, and ethical (SOLE).

The Berkeley food revolution seems to be catching on in the commercial world as well. Like the SOLE students, a large group of consumers prefer to buy organic, believing that in doing so they are protecting the environment, helping poor farmers, combating global warming, and leading healthier lifestyles. Especially to high-income consumers, these benefits make it worth paying an extra dollar or two for lunch or dinner. The stellar growth of Whole Foods and Trader Joe's, two high-end supermarkets that sell eco-friendly produce, has forced grocery mammoths like Safeway to introduce their own lines of organic foods. However, as The Economist reports, buying organic, fair-trade, and local foods might not accomplish the intended goals.

At first glance, organic foods seem to be net beneficial to the consumer diet and the environment. After all, humans have been eating organic food for most of history, since before the industrialization of food. However, The Economist argues that the health benefits of organic foods as opposed to genetically modified foods are unsubstantiated; that the production of organic foods is massively inefficient; that paying "fair" prices to poor farmers effectively subsidizes their bad agricultural choices; and that exclusively buying locally grown food sacrifices the gains from trade. In general, the article argues, the benefits of eating organic are exaggerated, and the costs are understated.

Discussion Questions

1. What actions does the article recommend to consumers who want to reduce the effects of global warming?

2. Economists generally agree that "real" free trade is a tide that raises all boats. Explain how the United States and the European Union have promoted protectionism in their agricultural sectors. If the U.S. and the EU were to stop subsidizing their own farming industries, how would world agriculture change?

3. Suppose you wanted to compare the costs and benefits of organic versus conventional agriculture. How would you go about doing that?