Multiproduct Cost Pass-Through: Edgeworth's Paradox Revisited

Edgeworth's paradox of taxation occurs when an increase in the unit cost of a product causes a multiproduct monopolist to reduce prices. We give simple illustrations of the paradox and a general analysis of the case of linear marginal cost and demand conditions, and we characterize which matrices of cost pass-through terms are consistent with profit maximization. When the firm supplies at least one pair of substitute products, we show how Edgeworth's paradox always occurs with a suitable choice of cost function. We then establish a connection between Ramsey pricing and the paradox in a form relating to consumer surplus.