The complicated simple economics of vertical mergers
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Citation (published version)Michael Salinger. "The Complicated Simple Economics of Vertical Mergers."
A common justification that economists have historically given for why competition authorities should generally tolerate vertical mergers is the successive monopoly model, in which a vertical merger results in a price reduction by eliminating double marginalization (EDM). That model does not include any rivals to one of the merging firms, so it assumes away both the possibility that a vertical merger can result in raising rivals’ costs (RRC) and or vertical upward pricing pressure. I extend the successive/complementary model to allow for differentiated duopoly in the sale of the final good. This structure is one of the two simplest possible settings to allow for EDM, RRC, and vertical upward pricing pressure (the other being duopoly upstream and monopoly downstream). Since this market structure leaves the competing downstream firm with no independent source of supply, it would seem to be the one most likely to give rise to anticompetitive pricing incentives. The model reveals, however, an additional competitive effect. Eliminating double marginalization not only removes a pricing distortion for the merging firm, but it can also increase competitive pressure on the rival and its input supplier (even if the merging firm is the input supplier). I consider a variety of functional forms for demand and allow for the stages to be either successive or complementary. RRC and an increase in one of the two consumer prices occurs in some cases, but the price the merged firm charges its downstream competitor does not increase (and, indeed, drops) in a surprisingly broad set of cases. The results suggest that any prediction of a price increase due to a vertical merger based on static pricing incentives will be sensitive to assumptions about the functional form of demand and the timing of decisions that may be hard to verify.