Question

 

a) A manufacturing rm merges with another firm to vertically integrate forward into the production of selling of products so as to engage in price discrimination. Such a vertical merger will increase all consumerswelfare.

b) Two firms merge together, only if the transaction cost must be reduced.

c) Specic human capital is a barrier of vertical integration.

d) The benet of coordination gives rise to vertical integration.

e) Consumer surplus decreases after two rms merge with each other.

Answer 1

a)A downstream monopsonist who integrates backwards into upstream supply will do so to increase its own profits. As it controls the means by which inputs get translated into goods for final consumers, the only way it can improve its profits is by lowering its own costs. If cost reduction involves any reduction in marginal costs, that will lower final good prices and enhance consumer surplus even where there is a downstream monopolist.

Inefficient vertical integration that either reduces the investment incentives of suppliers or forecloses on them will only be undertaken if it reduces the input costs of the monopsonist. Consequently, it must involve some beneficial reduction in double marginalisation or improvement in the bargaining position that overwhelms any other efficiency costs. As such, even if there is an overall reduction in welfare, the monopsonist and its consumers will always benefit.

b)The simple supply and demand market forces are not the sole factor influencing transaction prices. Just as important as market forces is the balance of power between buyers and sellers. This balance of power is constantly in flux, leading to unpredictability in pricing. This is particularly the case when there is a high volume of transactions between two companies.

These frequent transactions provide more opportunity for negotiation and exploitation. If one company is exploiting the other and raising transaction costs as a result, then vertical integration could eliminate the problem and reduce transaction costs.

Another instance where the balance of power between buyer and seller may have a considerable impact on transaction costs is one in which there is only one buyer and one seller in a particular market. In such a case, the companies are mutually dependent, which may lead to excessive negotiation and therefore to higher transaction costs. Again, vertical integration would reduce this unpredictability and lower transaction costs.

e)If the Mergers and Amalgamation's target is to expand the market, and are undertaken by dominant enterprises in the markets, it is very likely that they would result in a more concentrated or monopolied market structure. And in all likehood, these dominant enterprises might abuse their new power by raising prices, lowering quality standards in order to extract rents, whereas consumers are left with less or practically no choice. These are the cases where M&As were driven solely by the merging parties’ selfish objectives, at the cost of consumer welfare. Competition authorities, during their merger review process, often try to achieve a balance between producer surplus (brought about by economic concentration) and consumer surplus (brought about by competition).