Backward integration by a dominant firm

This paper studies the welfare consequences of a vertical merger that raises rivals' costs when downstream competition is à la Cournot between firms with constant asymmetric marginal costs. The main result is that such a vertical merger can nevertheless improve welfare if it involves a downstream firm whose cost is low enough. This is because by raising the input price paid by the nonmerging firms the merger shifts production away from those relatively inefficient producers in favor of the more efficient firm. Yet, there is a trade-off between the gain in productive efficiency and the loss in consumers' surplus caused by the higher downstream price that follows a higher input price. It is also shown, through an example, that this result extends to price competition with differentiated products.