Mergers Pt 2 (modelling unilateral effects with/out efficiency gains) (awful) Flashcards
Unilateral effects model: with no efficiency gains
what are overall results post-merger
Market power and price increases
Welfare falls
Insider: profits increases as long as Bertrand (but not in Cournot)
Outsider (firm 3): profits increase since assume no efficiency gains (both prices of inside/out increase! explains welfare loss!)
See set up working pg 8
Consumer surplus formula
Utility - Cost
U - R
What happens post merger between firm 1 and 2 in terms of products
now sell 2 products, firm 3 sells 1 (we assume only 3 products)
What about if we add efficiency gains - how does model set up differ from previous with none
Previous model with no efficiency gains, unit cost is just c, and > 0, both pre and post merger.
With efficiency gains, unit cost post merger is
ec, where e<1 (shows efficiency gains as helps cost fall) lower e means more efficiency gains
Magnitude of e: what does it determine?
magnintude of e determines whether rival will exit the market or not.
(recall from part 1, if efficiency gains are large, more likely to pursue strategy to undercut to gain market share! thus hard for rival to stay)
Why is efficiency gains dual-wield for the AA
efficiency gains can lower prices, good for consumers, makes it more likely for AA to approve the merger (CS increase)
however if prices go down too much, can kill competition. (recall, AA may block merger if they believe they don’t have capacity to serve market)
So with efficiency gains we expect price reduction
What do we expect for CS, outsider profits and total welfare
CS increase
Outsider profits to fall
But total welfare could increase….
Empirical observations of mergers and size of firms
Mergers are between small firms are more likely to have intent to make efficiency gains, cost-savings and thus not raise prices. Thus more likely approved
while large firm merging tend to get higher prices i.e intend to exercise market power so less likely to go ahead.
Now consider vertical relationships
Assume process:
Manufacturer > retailer > consumers
Why does manufacture have incentive to control some of retailer actions i.e to vertically merge
As manufacturer profits and demand, relies on retailer to advertise adequately the product.
Vertical restraints are agreements between the 2 stages.
tightest form of restraint is vertical integration (merger)
What other examples of VR’s. (5)
non-linear pricing
quantity discount
resale price maintenance (control the retail price i,e RRP!)
quantity fixing
exclusivity clauses
Recall we said vertical integration can remove externalities: (2)
Double marginalisation: remove mark-up in stages, prevents market price being too high
Free-riding in marketing: if manufacturer is producing to a market with many retailers, there is incentive for retailers to free-ride on marketing services, and recall how retailer affects manufacturer profits by advertising adequately; thus integration to gain control is better for them.
Double marginalisation model:
Single manufacturer & retailer (each monopolists)
Upstream (manu) charge w>c , thus
Downstream charges P>w>w
Demand q=a-p
What is the PM problem (πd) for downstream?
b) then find price and quantity from that
C) then find profit max problem πu for upstream, to find w (their price, downstreams cost)
(Working pg 13)
Max πd = (p-w)(a-p)
b) FOC respect to pq
C) max πu = (w-c)(a-w/2)
FOC respect to w and rearrange to find w.
Now have w, can find final P, final πu and πd
And PS (πd+πu)
Pg 14
So that was separate entities, i.e double marginalisation.
What about if we had vertical integration pg 14 slide 2.
B) what can we conclude between results of vertical integration vs not.
Only one firm, so monopoly, standard values of q p and profit
B) CS and PS is higher from vertical integration as a result of no intermediary cost. So increase in total welfare (keeps costs lower, so allows market price not to be too high, so good for both)
2nd externality internalised: free ride marketing.
1 upstream firm U, 2 downstream D1, D2
Choose effort level e (of retailer) to advertise etc
This costs money obviously so retailer cost
C(q,ei) = wq + μei²/2 (wq variable cost)
A) Perceived quality of product expression (u)
What is equilibrium with no vertical integration, assuming they compete in prices and no double marginalisation
u = ubar + e, where e= e1+e2 (since free-ride)
ubar: inherent quality
B)
e1=e2=0 due to free riding (no retailer exerts effort as want to free ride)
And as price competition retailers set P=MC which is w! so p1=p2=w
So key result we get
With price comp, P1=P2=w i.e downstream firms (retailers) make no profit
So separate entities, downstream makes no profit as compete prices.
What about upstream firm maximisation problem given demand q=v-w
B) then find welfare (Ws) PS, CS
Working all pg 15
Max Πu = (w-c)(v-w)
FOC and rearrange to get w= v+c/ 2
Then can find answers to B from there
Now let vertical integration occur. We should expect findings to..
Now we only have 1 profit max problem πm (not separate πd and πu)
Now we include effort levels , what is max problem
B) then can find ei, p, q, PS, CS and Wm (welfare)
This is so long working.
C) main result
Max πm = (p-c)(v+e1+e2-p) - μe²₁/2 - μe²₂/2
B) This working is so long on pg16, as long as understand steps
C) vertical integration improves welfare compared to separate entity (under provision of marketing due to free-riding is solved)
So these examples of externality internalising (double marginalisation and free-riding marketing) have increased welfare
However, welfare may not always increase from vertical merger.
Assume population to be 1
A proportion λ have high willingness to pay øh (high price)
The rest (1-λ) have low valuation øL, but appreciate effort on behalf of seller so øL + e
What happens in separation for retailers who compete in price
B) what about the manufacturer? What are their options
Same as normal separation; Retailers exert no effort, thus e1=e2=e=0, and breakeven P=MC as compete on price.
B)
Manufacturer can set a price (w) equal to øL or øH.
Assume manufacturers set price = øL (low valuation)
I.e w=øL
What is PS, CS and Ws
Ps = (øL - c) x 1
X by 1 as they capture the full population market which we let =1 (can sell to both high and low valuation groups)
CS = λ(øh - øL)
Ws = CS+PS
Now let vertical integration occur
Maximisation problem
Maxπm = p-c - μe²₁/2 - μe²₂/2….
Now with merger, we include effort levels
Max
What do we find overall for welfare
Welfare is less with merger if λ<1/2 i.e if less proportion of people with high valuation, less profit to extract from them
Total welfare drops when too many low value consumers exist, since cost of effort exceeds the benefit
