External Reference Pricing Under Incomplete Information

ABSTRACT This study points out that the information owned by domestic monopolies plays a crucial role in the formulation of the government's differential External reference pricing (ERP) policy. Our key findings are that first, under an uninformed government and informed manufacturer (G1), only the pooling policy is an equilibrium. In other words, the government is unable to enhance the welfare of the society through differential ERP policies. Second, under an uninformed government and uninformed manufacturer (G2), if the difference between the two types of foreign market is comparatively small and the probability of a high‐type foreign market is law enough; the separating policy is an equilibrium. That is, in this case, the government can enhance the welfare of the society through differential ERP policies. Finally, social welfare under G2 is no worse than that under G1, even though under G1, monopolies can fully capture the reservations of foreign retailers; however, under G2, monopolies cannot fully capture the reservations of foreign retailers. It is detrimental to the social welfare of the country for the domestic monopoly to have more information, even if this can capture more of the retained profit level of the foreign retailers.