IDEAS home Printed from https://ideas.repec.org/p/ste/nystbu/94-05.html
   My bibliography  Save this paper

The Incentive for Vertical Integration

Author

Listed:
  • Nicholas Economides

Abstract

We evaluate the incentive to integrate vertically in a simple 2X2 Bertrand model of two substitutes that are each comprised of two complementary components. We confirm 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 firms are independent (independent ownership). The reason for the change in 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.

Suggested Citation

  • Nicholas Economides, 1994. "The Incentive for Vertical Integration," Working Papers 94-05, New York University, Leonard N. Stern School of Business, Department of Economics.
  • Handle: RePEc:ste:nystbu:94-05
    as

    Download full text from publisher

    File URL: http://raven.stern.nyu.edu/networks/94-05.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Economides, Nicholas & Salop, Steven C, 1992. "Competition and Integration among Complements, and Network Market Structure," Journal of Industrial Economics, Wiley Blackwell, vol. 40(1), pages 105-123, March.
    2. Schmalensee, Richard, 1973. "A Note on the Theory of Vertical Integration," Journal of Political Economy, University of Chicago Press, vol. 81(2), pages 442-449, Part I, M.
    3. Michael A. Salinger, 1988. "Vertical Mergers and Market Foreclosure," The Quarterly Journal of Economics, Oxford University Press, vol. 103(2), pages 345-356.
    4. Comanor, William S & Frech, H E, III, 1985. "The Competitive Effects of Vertical Agreements?," American Economic Review, American Economic Association, vol. 75(3), pages 539-546, June.
    5. Salinger, Michael A, 1989. "The Meaning of "Upstream" and "Downstream" and the Implications for Modeling Vertical Mergers," Journal of Industrial Economics, Wiley Blackwell, vol. 37(4), pages 373-387, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Nicholas Economides, 2007. "Nonbanks in the payments system: vertical integration issues," Proceedings – Payments System Research Conferences, Federal Reserve Bank of Kansas City.

    More about this item

    JEL classification:

    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • D4 - Microeconomics - - Market Structure, Pricing, and Design

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ste:nystbu:94-05. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Viveca Licata). General contact details of provider: http://edirc.repec.org/data/ednyuus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.