Question

1. (30) True or False (explain your answer briefly. A simple "true" or "false" without
explanation will get zero point)
a) (6 points) An upper stream manufacturing rm merges with another downstream distri-
bution firm so as to engage in price discrimination. Such a vertical merger will decrease all
consumer'swelfare.
b) (6 points) Two firms merge together, only if the transaction cost must be reduced.
c) (6 points) Specic human capital is a barrier of vertical integration.
d) (6 points). The benet of coordination gives rise to vertical integration.
e) (6 points). Social welfare decreases after two firms merge with each other.

Answer 1

a. Note that vertical merger is a condition where the two and more stages of production which previously operated by different firms got integrated. With the vertical merger, as firms get access to two different markets, they now engage in price discrimination. This is because, with more control or complete control (monopolist) across the processes in an industry, the higher prices can now be charged based on the reservation price of the people or the inelastic demand of the buyers later in the process. The higher price or the price differentiation thus reduces the consumer's welfare. Thus, this statement is true.

b. When two firms trade with each other, there are some transaction costs which must be incurred by these firms, where one firm might be exploiting other firms. Thus when these firms merge, then the transaction costs will reduce. Hence this statement is also true.

c. Vertical integration means that the single firm now will be controlling more than one process. However note that if one of these firms requires some special or specific human capital, then one firm will not be able to manage the whole of the integrated process. Thus, specific human capital acts as a barrier to vertical integration. Hence this is also true.

d. On the other hand, suppose that the processes previously owned or managed by the different firms but require coordination, let's say about the number and type of material to be made at the earlier stage for the later stage, then, in that case, the vertical integration or management by the single firms would be more useful hence this statement is also true.

e. Now when two firms integrate and have more control over the production line, then these firms have better control over the pricing. This pricing, on one hand, decreases consumer welfare while increases producer welfare. Thus the net effect on social welfare which is the sum of consumer and producer welfare or surplus is not sure. Thus this statement may or may not be true. So, not true.