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

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

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

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

Vertical Integration to Monopolize This slideshow was written by Ken Chapman, but is substantially based on concepts from Modern Industrial Organization by Carlton and Perloff, 4 th edition, McGraw-Hill. Inputs Energy, ELabor, L Final Good Q=f(E,L) Consumers, Q Figure 12.1 Assumptions: Constant returns to scale Constant marginal cost inputs Monopoly upstream Competition Downstream Vertical integration is costly Upstream Downstream m ew P

When will a monopoly supplier of Energy Vertically Integrate?  Fixed Proportions Downstream No incentive to vertically integrate  Variable Proportions Downstream 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, McGraw-Hill.

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

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

Solutions to Double Markup Problems  Vertical Integration  Quantity Forcing 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, McGraw-Hill.

Free Riding Among Distributors  What is it?  Solution Methods 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, McGraw-Hill.

Free Riding Among Manufacturers  What is it?  Solutions 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, McGraw-Hill.