Free entry and social efficiency under vertical oligopoly

Abstract

We analyze a successive vertical oligopoly model that incorporates vertical relationships between industries and demonstrate that free entry in an industry that produces a homogeneous product can lead to a socially insufficient number of firms. This is in contrast with the previous findings that, under Cournot oligopoly with fixed set-up costs, level of entry in the free-entry equilibrium is socially excessive. It has often been argued that this result can provide a justification for apparently anticompetitive entry regulations. Our finding yields an important policy implication that such a justification is not necessarily valid when vertical relationships are taken into account.

Horizontal Mergers in the Presence of Vertical Relationships

“…Note that the downstream firms have no oligopsony power over the upstream sector. This assumption is in line with the previous literature on vertical oligopolies-see, for example, Greenhut and Ohta (1979), Salinger (1988), Ghosh and Morita (2007), and Peitz and Reisinger (2013)-where downstream firms take the input price as given when they make a production decision. 4 We consider the subgame perfect Nash equilibrium (SPNE) in pure strategies of the game.…”

“…1 Mankiw and Whinston (1986) and Suzumura and Kiyono (1987) show that, under a Cournot oligopoly model with fixed set-up costs, the level of entry in the free-entry equilibrium is socially excessive. Ghosh and Morita (2007) find that free entry can lead to a socially insufficient number of firms in a successive oligopoly model, but it can still be socially excessive under a range of parameterizations. In the context of socially excessive entry, our findings tell us that the downstream merger can increase welfare by mitigating the negative welfare effect of excessive entry.…”

“…Mankiw and Whinston (1986) and Suzumura and Kiyono (1987) show that the free-entry number of firms in a homogenous products Cournot oligopoly is socially excessive. 10 In a vertical oligopoly framework such as ours, the free-entry number of upstream firms can be socially insufficient or excessive (see, for example, Ghosh and Morita, 2007). Excessive entry is necessary for welfare improvement of downstream mergers in our framework.…”

Cooperative R&D under uncertainty with free entry

“…12 This can be seen as a long run approximation to an industry where some costs are sunk in the short run. 13 See, for example, Lee and Wilde (1980), Mankiw and Whinston (1986), and Ghosh and Morita (2007). See Seade (1980) for a justification (p. 482).…”

Free entry and social inefficiency under co-opetition

“…Some previous studies find that free entry can result in socially insufficient entry (e.g., Spence 1976, Dixit and Stiglitz 1977, Kühn and Vives 1999, and Ghosh and Saha 2007. Ghosh and Morita (2007) consider a vertical relationship between industries in a homogeneous Cournot model and show that free entry in the upstream sector can lead to socially insufficient entry. The driving force behind their insufficient entry result is that entry in the upstream sector has positive external effect on the downstream sector's profit.…”