Equilibrium Vertical Foreclosure with Investment
One of the most enduring controversies in antitrust concerns the potential foreclosure effects of vertical integration. In a recent paper, Ordover, Saloner and Saloner and Salop (1990) construct a model of vertical integration in which vertical foreclosure emerges as the equilibrium outcome. However, as is well-known, OSS's result breaks down if the vertically integrated firm cannot make the price commitment. In this paper, we reexamine the foreclosure theory of vertical integration by extending OSS's model to include upstream market power and investments. Cost-reducing investments introduce a channel through which the integrated firm can credibly commit itself to a higher input price at which it is willing to supply the unintegrated downstream firm. We show that a profitable but anticompetitive (both for consumer welfare and for aggregate efficiency) vertical causing hold-out problems between the input suppliers. In contrast to OSS's model, where vertical integration (even with commitment) is not effective under Cournot downstream competition, vertical integration in our model can be both effective and anticompetitive even under Cournot downstream competition.
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