Catherine C. de Fontenay and Joshua S. Gans
"Can vertical integration by a monopolist harm consumer welfare?"
JEL codes: L42
Keywords: Monopsony, bargaining, vertical integration, consumer welfare

Abstract: Vertical integration by a monopsonist is generally believed not to harm consumers. This paper demonstrates, in a natural economic setting, that this conventional wisdom may not hold. We model one-on-one bargaining between a monopsonist and independent suppliers when the set of suppliers cannot be expanded easily ex post and show that a vertically separated monopolist is vulnerable to hold-up. Without integration, we demonstrate that a bottleneck monopsonist has an incentive to encourage more upstream entry than would arise in a pure neoclassical monopoly. Having more suppliers mitigates the hold-up power of any one. This, however, distorts the cost structure of the industry toward greater industry output and, hence, lowers final good prices. Vertical integration mitigates the hold-up problem faced by the monopsonist. It allows it to generate and appropriate a greater level of industry profits; at the expense of consumers.

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