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Mergers with Quality Differentiated Products

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  • Matthew J. Baker

    () (United States Naval Academy)

  • Pamela M. Schmitt

    () (United States Naval Academy)

Abstract

We consider the impact of merger on the equilibrium price and quality of products. Consumer demand for both products depends not only on own price and quality, but also on the price and quality of the other product. We consider both the case in which the merging firms produce gross complements, and the case in which the firms produce gross substitutes. In both cases, merger may lower or increase both product price and quality. In the case in which firms produce complementary products, it may happen that firms both lower price and increase product quality when merged. This happens when the cross quality elasticities of demand and the cross price elasticities of demand are equal in magnitude. Surprisingly, we also find that there are situations under which merger between firms producing substitutes increases welfare. For example, it is possible that merger between firms producing gross complements may result in higher product quality but lower social welfare, and merger between firms producing substitute products may result in lower product quality but higher social welfare.

Suggested Citation

  • Matthew J. Baker & Pamela M. Schmitt, 2003. "Mergers with Quality Differentiated Products," Departmental Working Papers 3, United States Naval Academy Department of Economics.
  • Handle: RePEc:usn:usnawp:3
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    File URL: http://www.usna.edu/EconDept/RePEc/usn/wp/usnawp3.pdf
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    References listed on IDEAS

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    1. Farrell, Joseph & Shapiro, Carl, 1990. "Horizontal Mergers: An Equilibrium Analysis," American Economic Review, American Economic Association, vol. 80(1), pages 107-126, March.
    2. Pesendorfer, Martin, 2003. " Horizontal Mergers in the Paper Industry," RAND Journal of Economics, The RAND Corporation, vol. 34(3), pages 495-515, Autumn.
    3. Allen N. Berger & Anil K. Kashyap & Joseph M. Scalise, 1995. "The Transformation of the U.S. Banking Industry: What a Long, Strange Trips It's Been," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 55-218.
    4. Cabral, Luis M. B., 2003. "Horizontal mergers with free-entry: why cost efficiencies may be a weak defense and asset sales a poor remedy," International Journal of Industrial Organization, Elsevier, vol. 21(5), pages 607-623, May.
    5. Schmalensee, Richard, 1987. "Horizontal Merger Policy: Problems and Changes," Journal of Economic Perspectives, American Economic Association, vol. 1(2), pages 41-54, Fall.
    6. 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.
    7. Avinash Dixit, 1979. "Quality and Quantity Competition," Review of Economic Studies, Oxford University Press, vol. 46(4), pages 587-599.
    8. Sheshinski, Eytan, 1976. "Price, Quality and Quantity Regulation in Monopoly Situations," Economica, London School of Economics and Political Science, vol. 43(17), pages 127-137, May.
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