# Vertical Integration and Assurance of Markets

## Abstract

Four incentives for the vertical integration of firms have frequently been mentioned in the literature. Mergers may result from market power in either the primary-resource, intermediate-product or final- product markets.^{1} Technological advantages accruing to combination can arise through increasing returns,^{2} information advantages^{3} or decreased transactions costs, when firms place themselves in a cooperative rather than an adversarial relationship.^{4} Tax avoidance provides a third reason for integration.^{5} More generally, integration opens up a wider range of strategies in the face of regulation and more flexibility in implementing them. Finally, imperfections in the market for the intermediate product may lead firms to combine in order to bypass these problems by transferring goods internally.^{6} This chapter addresses the last of these issues. In particular, it studies the problem of price inflexibility in an intermediate-product market which is beset by stochastic demands, and the temporary shortages and gluts of this product that result. We hypothesise that firms choose to integrate if the expected profit from doing so exceeds that of the separate divisions acting independently. Both descriptive and normative conclusions regarding such an industry are drawn on the basis of the model presented.

## Keywords

Intermediate Product Vertical Integration Expected Profit Excess Demand Profit Function## Preview

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