Which of the following is an effective way for a firm to overcome the problem of double marginalization?

• A. Reducing production to create scarcity
• B. Vertical integration of the supply chain
• C. Increasing the price of the final product
• D. Imposing tariffs on imported inputs

Answer: (B)

Verified step by step guidance

1. Understand the concept of double marginalization: it occurs when two firms in a supply chain each mark up prices above marginal cost, leading to higher final prices and reduced overall profits.
2. Recognize that double marginalization results from separate firms each exercising market power independently, causing inefficiencies in the supply chain.
3. Identify that an effective way to overcome double marginalization is to align incentives across the supply chain, which can be done through vertical integration—where a single firm owns multiple stages of production or distribution.
4. Note that vertical integration eliminates the separate markups by combining the firms, allowing the integrated firm to set prices that maximize joint profits rather than individual profits at each stage.
5. Understand why other options like reducing production, increasing prices, or imposing tariffs do not effectively solve double marginalization, as they do not address the root cause of separate markups by independent firms.