Reexamining the effect of the most-favored-nation provision in input prices on R and D incentives Jeong-Yoo Kim a, ⁎ , Jae Nahm b,1 a Department of Economics, Kyung Hee University, 1 Hoegidong, Dongdaemunku, Seoul 130-701, Korea b Department of Economics, Hong Kong University of Science and Technology, Clearwater Bay, Kowloon, Hong Kong Received 6 June 2005; received in revised form 5 April 2006; accepted 6 April 2006 Available online 2 June 2006 Abstract We examine the effect of the most-favored-nation provision in input prices on downstream firms' R and D incentives. Contrary to the previous literature, we show that the effect depends on the extent of substitutability between downstream firms if they compete in two-part tariffs. When a downstream firm lowers its marginal cost, it entails two conflicting effects on the upstream firm's pricing for inputs, the standard elasticity effect of penalizing the low-cost firm and the market share effect of rewarding it. If substitutability between downstream products is high enough, the latter dominates the former, and thus downstream firms will choose a higher marginal cost technology under the MFN provision. © 2006 Elsevier B.V. All rights reserved. JEL classification: L11 Keywords: MFN provision; Price discrimination; Two-part tariff; Access charge 1. Introduction Competing firms in the downstream market often buy their inputs from a common input supplier (upstream firm). Examples abound. Long-distance call service providers must purchase access service from a local carrier. Publishers supply books to many competing retail bookstores. One important policy issue is whether or not upstream firms should be allowed to charge discriminatory input prices. Banning discriminatory wholesale prices dates back to the International Journal of Industrial Organization 25 (2007) 201 – 217 www.elsevier.com/locate/econbase ⁎ Corresponding author. Tel.: +82 2 961 0986. E-mail addresses: jyookim@khu.ac.kr (J.-Y. Kim), jnahm@ust.hk (J. Nahm). 1 Tel.: +852 2358 7626. 0167-7187/$ - see front matter © 2006 Elsevier B.V. All rights reserved. doi:10.1016/j.ijindorg.2006.04.013