There exists an economic phenomenon called double marginalization. What exactly is it?

The formal definition is: Double marginalization occurs when firms at different vertical levels of the same industry's supply chain (e.g., upstream and downstream) each possess market power and apply their own price markups.

In other words, double marginalization refers to the situation where different companies at various vertical stages of a supply chain each exercise their market power to impose successive price markups.

Since each markup layer creates significant deadweight loss, the double marginal effect compounds this loss by making it occur twice, thereby amplifying overall efficiency loss.

One method to avoid losses from double marginalization is vertical integration of the two companies, which eliminates at least one layer of markup-induced loss. This can be achieved through supply chain mergers or one company acquiring another.

When a firm possesses market power, it sets prices above marginal cost, resulting in welfare loss.

This phenomenon becomes particularly pronounced when a company with market power purchases products from another company with market power. The producer marks up prices above marginal cost when selling to downstream firms, who then apply another markup when selling final products to end-users.

This means the final product price undergoes two markups based on marginal costs: one by the manufacturer and another by the retailer. This constitutes the double marginal effect.