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A Price Theory of Vertical and Lateral Integration

  • Patrick Legros
  • Andrew F. Newman

This article presents a perfectly competitive model of firm boundary decisions and study their interplay with product demand, technology, and welfare. Integration is privately costly but is effective at coordinating production decisions; nonintegration is less costly but coordinates relatively poorly. Output price influences the choice of ownership structure: integration increases with the price level. At the same time, ownership affects output, because integration is more productive than nonintegration. For a generic set of demand functions, equilibrium delivers heterogeneity of ownership and performance among ex ante identical enterprises. The price mechanism transmutes demand shifts into industry-wide reorganizations and generates external effects from technological shocks: productivity changes in some firms may induce ownership changes in others. If the enterprise managers have full title to its revenues, market equilibrium ownership structures are second-best efficient. When managers have less than full revenue claims, equilibrium can be inefficient, with too little integration. JEL Codes: D21, D23, D41, L11, L14, L22. Copyright 2013, Oxford University Press.

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Article provided by Oxford University Press in its journal The Quarterly Journal of Economics.

Volume (Year): 128 (2013)
Issue (Month): 2 ()
Pages: 725-770

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Handle: RePEc:oup:qjecon:v:128:y:2013:i:2:p:725-770
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