Firms at different stages of the production chain have market power. Each firm implements its own monopolostic mark-up. This distorts the decsion of downstream firms.
This lack of co-ordination of their pricing decisions leades the double marginalization phenomenon.
A vertical marger will be able to reduce this welfate loss by incorporating both costs inside the same decision maker, and do internalizing the externality.
Example- Producer M c=2, Retailer F c=w, Q=20-P. Find with no merger
Analyse the Retailers decision:
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Maxmise profits
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This is the demand funtion for the manufacturer
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Analyse the manufactuers decision
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Max profits
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Find w, P, Q
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Double Marginalization
Now suppose the firms merge.
One single monopoly with demand Q=20-P, Mc=2.
Monopoly maximises profits by MR=MC
TR=
MR=
MR=MC
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Q=
P=
Merger has benefited the two firms. Proit post merger>profit pre merger
Merger has benefited consumers.
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Anticompetitive Impacts
Analysis so far suggests that anti-trust authorities should be less concerned about the welfare impact of vertical mergers that the impact of horizonal mergers.
Based on two important assumptions:
There is a signle market in which final goods are sold
There is a monopoly at each stage in the vertical chain
Consider relaxing these assumptions
Price discrimination
Vertical Foreclosure
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Price Discrimination
Upstream firm selling to two downstream markets.
Seller wants to price discriminate between these markets. Sets v1<v2.
Suppose that buyers can arbitrage
Buyer 2 offers to buy from buyer 1 at a price va(between v1 and v2)
Arbitrage prevents price discrimination
If the seller integrates into market 1 arbitrage is prevented
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Vertical Foreclosure
Suppose that instead of monopoly at both stages of production, we had monopoply at one stage and a competitive sector at the other.
Either price competittion among manufactures leads to a wholesale price =MC
Or price competition among retailers leads to a retails price = upstream price + downstream MC
In either case, no double marginalization problem, so no efficient gain to vertical integration.
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