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Vertical Relationship and Regulation: The Case of Essential Facility

This paper studies the strategy of an upstream monopoly which sells an essential facility to a downstream regulated firm by means of two-part tariff, in a regulatory environment a la Ramsey-Boiteux with a unique budget constraint over all the regulated activities. It is shown that the upstream monopoly obtains greater profits when there is regulation than when there is not, i.e. when the upstream monopoly deals directly with the downstream firm. Therefore, if it has this opportunity, the regulator chooses not to regulate the downstream firm in order to limit this rent extraction.