Vertical Integration p Definitions n n p Vertical

Vertical Integration p Definitions n n p Vertical Integration Vertical Restrictions Key issues n n Why vertically integrate? Why use vertical restrictions? Should government oppose vertical integration and/or vertical restrictions? This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.

Costs of Vertical Integration Costs may be higher than that provided by competitive suppliers p Larger firms are harder to manage p Legal costs of merging may be high p This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.

Benefits of Vertical Integration Lower Transactions Cost p Assured Supply p Avoidance of Market Failure p n Franchising at Mc. Donalds and the reputation externality Avoiding Government Rules p Gaining Market Power p Eliminating Market Power p This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.

Integration to lower transactions costs Specialized Assets (specific capital) p Uncertainty p Transactions involving Information p Extensive Coordination p This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.

Vertical Integration to Monopolize Assumptions: • Constant returns to scale • Constant marginal cost inputs • Monopoly upstream • Competition Downstream • Vertical integration is costly Inputs m Energy, E Labor, L e w Upstream Final Good Q=f(E, L) P Downstream Consumers, Q Figure 12. 1 This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.

When will a monopoly supplier of Energy Vertically Integrate? p Fixed Proportions Downstream n p No incentive to vertically integrate Variable Proportions Downstream n Will vertically integrate if extra monopoly profit exceeds costs of integration This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.

Fixed vs. Variable Proportions Labor, L Energy, E This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.

Vertical Restrictions: Double Monopoly Markup Manufacturer's Price, ρ Retail Price, P P=100 -2 Q P=100 -Q MC = $10 25 50 MR=100 -4 Q Quantity, Q 50 MR=100 -2 Q This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill. 100 Quantity, Q

Solutions to Double Markup Problems Vertical Integration p Quantity Forcing Restrictions p This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.

Free Riding Among Distributors What is it? p Solution Methods p n n Exclusive Territories Resale Price Maintenance This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.

Free Riding Among Manufacturers What is it? p Solutions p n Exclusive Dealing This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, Mc. Graw-Hill.