Impacts Of Vertical Integration On Downstream Quality Innovation In Vertically Differentiated Markets

Vertical integration and its effects have been problems of concern in the theory of industrial organization and antitrust policy. Researchers have not reached an agreement about the welfare effects of vertical integration. On the one hand, not only can vertical integration decrease the transaction costs, eliminate transaction risks, and enhance the realization of the economy of scale and economy of scope but can dispose the problem of double marginalization, reduce the price of final products, and improve the social welfare. On the other hand, monopoly enterprises can extend their monopoly power, increase the costs of competitive firms, and produce the market foreclosure effect by vertical integration. With the development of research, economists begin to pay attention to the impacts of vertical integration on innovation. Most of such researches are under the hypothesis of homogeneous products and focus on the process innovation. However, products are always vertically differentiated in reality and product innovation also plays an important role. Therefore, the research on impacts of vertical integration on product innovation in quality differentiated markets is of both theoretical and realistic significance.This paper establishes a model of impacts of vertical integration on downstream innovation in vertically differentiated markets, discusses the impacts of vertical integration on downstream innovation when downstream firms conduct Bertrand or Cournot competition respectively, and analyses the welfare effects. The following results are concluded:vertical integration will promote the innovation of integrated firm and inhibit the innovation of competitive firm no matter the downstream firms conduct Bertrand or Cournot competition. Vertical differentiation can weaken the market foreclosure effect of vertical integration under downstream Bertrand competition. The total profits of producers are increased after vertical integration under downstream Bertrand competition while decreased under downstream Cournot competition. For the welfare effects of vertical integration, the social welfare is deteriorated under downstream Cournot competition while the situation of Bertrand competition depends on the extend of product differentiation.