Answer to Question #123089 in Economics for John

Question

Vertical mergers have the potential of substantially reducing competition in a market, and force other firms in the market to also merge. Why does this occur in an industry? What happens to firms who fail to merge vertically ?

Answer 1

There are several reasons for vertical mergers to occur in the market:

1) when an upstream and a downstream firm in one chain have monopoly power, they are forced to reduce their output from a competitive level to the monopoly level, both of them will have deadweight losses. After the merger, they will have fewer losses.

2) in a competitive market some firms decide to merger an upstream or a downstream firm to cut costs and gain a competitive advantage;

3) sometimes mergers happen in the situation when an upstream or a downstream firm in one chain on the verge of bankruptcy. To save their own business companies merge their suppliers or processing companies.

Firms who fail to merge vertically have bigger costs or even may go bankrupt if they lose their only supplier or consumer.