|
Archive@NYU >
NET Institute >
NET Institute Working Papers Series >
Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/28418
|
| Title: | The Incentive for Vertical Integration |
| Authors: | Economides, Nicholas - NYU Stern School of Business |
| Keywords: | Mergers, vertical integration |
| Issue Date: | 2005 |
| Series/Report no.: | NET Institute Working Paper;05-01 |
| Abstract: | This paper evaluates the incentive of firms to vertically integrate in a
simple 2X2 Bertrand model of two substitutes that are each comprised of
two complementary components. It confirms that all prices fall as a
result of a vertical merger. Further, we find that, when the composite
goods are poor substitutes, producers of complementary components are
better off after integration. Thus, at equilibrium, each pair of
complementary goods is produced by a single firm (parallel vertical
integration). In contrast, when the composite goods are close
substitutes, vertical integration reduces profits of the merging firms
and is therefore undesirable. Thus, at equilibrium, all four products
are produced by independent firms (independent ownership). The reason
for the change in the direction of the incentive to merge is that, as
the composite goods become closer substitutes, competition between them
reduces prices (in comparison to full monopoly) thereby eliminating the
usefulness of a vertical merger in accomplishing the same price effect.
We also find that, for intermediate levels of substitution, firms
producing complementary components prefer to merge only if the
substitute good is produced by an integrated firm. Thus, for
intermediate levels of substitution, both parallel vertical integration
and independent ownership are equilibria. When the demand system is
symmetric, total surplus is higher in parallel vertical integration, for
all degrees of substitution among the products, even for the case when
the goods are close substitutes and parallel vertical integration is not
the equilibrium outcome. Thus, the market provides less vertical
integration than is optimal from a social surplus maximizing point of view. |
| URI: | http://hdl.handle.net/2451/28418 |
| Appears in Collections: | NET Institute Working Papers Series
|
All items in Faculty Digital Archive are protected by copyright, with all rights reserved.
|
