Paul Krugman has an op-ed today where he argues Amazon is abusing its power:

Which brings us back to the key question. Don’t tell me that Amazon is giving consumers what they want, or that it has earned its position. What matters is whether it has too much power, and is abusing that power. Well, it does, and it is.

Amazon is attempting to negotiate lower prices from the publisher Hachette and is slowing down sales of Hachette books on amazon.com in an attempt to force their hand. This is the main evidence.

But this kind of bargaining leads to lower prices for consumers not higher. Hence, from the perspective of welfare it is actually good. It is akin to the argument for reducing double marginalization via vertical integration. Double marginalization occurs because the primary producer (here Hachette) and the retailer (here Amazon) BOTH add a margin on to costs to maximize profits. Welfare would be higher and prices lower if they vertically integrated so some externalities are internalized. In fact, here is Krugman in 2000 explaining why breaking up Microsoft into Windows and Office is a bad idea:

In the last few days the Justice Department, outraged by the lack of contrition among Microsoft executives, has apparently decided to seek a ”horizontal” breakup of the software company — that is, to split it into one company that sells the Windows operating system (the upstream castle) and another that sells Microsoft Office and other applications (the downstream castle)….

even if you believe that Bill Gates has broken the law, you don’t want to impose a punishment that hurts the general public. And even strong critics of Microsoft have worried that a horizontal breakup would have a perverse effect: the now ”naked” operating-system company would abandon its traditional pricing restraint and use its still formidable monopoly power to charge much more. And at the same time applications software that now comes free would also start to carry hefty price tags.

As we know from ECON 101, integration is just one way to internalize externalities. Another would be for the retailer to negotiate lower prices from the producer so they are closer to production costs. Another would be for the producer to force the retailer to charge a lower margin. As both sides try to negotiate such deals which are good for them but bad for the other side, there is a war of attrition as we see currently. Sure Amazon’s tactics may be a bit crude but this is the typical kind of negotiation that lowers input costs and eventually prices. Hachette’s tactics are harder to observe but I would bet they are not so different.

(Update Oct 21: Spelled out some more details!)

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