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Horizontal Mergers 1

Horizontal Mergers 1. Profit incentive Profit = Π = P*Q-ATC*Q Merger  +Δ Π by +Δ P only because of increased monopoly power: welfare loss Dominant firm model Merger  +Δ Π by -Δ ATC only: welfare loss? + economies of scale (only horizontal mergers)

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Horizontal Mergers 1

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  1. Horizontal Mergers 1 • Profit incentive • Profit = Π = P*Q-ATC*Q • Merger  +Δ Π by +Δ P only because of increased monopoly power: welfare loss • Dominant firm model • Merger  +Δ Π by -Δ ATC only: welfare loss? • + economies of scale (only horizontal mergers) • + cost complementarities (all mergers) • + management efficiency (all mergers)

  2. Horizontal Mergers 2 • Merger  +Δ Π by +Δ P and by -Δ ATC: welfare loss? • Internal expansion efficiencies vs. merger efficiencies • Market evidence on efficiencies - stock prices of rivals • Market evidence on price effects - airlines

  3. Horizontal Mergers 3 • Market evidence on welfare losses from railroad merger • Welfare gain=+C+D-A-B • For railroad case: Industry-wide mark-up = 34%; price elasticity = -1.0; merger would reduce costs by 5%; and would raise prices by 15% • P1 = $63.64 so MC1=AC1=$63.64/1.34=$47.49 and MC2=.95*MC1=$45.12 • P2= MC2*1.34*1.15= $69.53 which is 9.26% higher than P1 • Since elasticity = -1, % change in Q will equal % change in P, so Q changes by -9.26% from Q1 of 35.3 or Q2=32.04 million • So A=(1/2)(b*h)=.5*($69.53-$63.64)*(35.3-32.04)=$3.26 million; B=b*h=$52.64 million; C=$188.72 million and D= $75.93 million and the welfare gain = $157.8 million • Alternative assumptions yield -$85.9 million P2 A C P1 B AC1-MC1 D AC2=MC2

  4. Horizontal Mergers 4 • Legal basis:Sherman + Clayton acts • “in any line of commerce in any section of the country …substantially lessen competition” • Hart-Scott-Rodino (1976): Notification of intent and 30 days for gov’t to rule • Merger guidelines: Post merger HHI • Level of HHI: <1000, 1000-1800, >1800 • Change in HHI:<50, 50-100, >100

  5. Horizontal Mergers 5 • Merger guidelines: Entry conditions • Merger guidelines: Ease of collusion • Merger guidelines: Efficiencies

  6. Horizontal Mergers 6 • Case: Brown Shoe (1962) illegally merged ( • Geographic market: Only cities with both! No economic analysis • Market shares were very small in both mfg and retail (5% and 7.2%) but found to be significant • Case: PNB (1963) illegally merged with Girard • Geographic market based on logic only • No economic analysis of effects

  7. Horizontal Mergers 7 • Case: Coca Cola (1986) blocked • Coke 37.4% (1399); 42.0% (1764); (+365-21) • Pepsi 28.9% (835); 34.6% (1197); (+162-32) • Seven-up 5.7%(32) • Dr. Pepper 4.6% (21) • CASES: INCIPIENCY VS. COST OF BREAK-UP

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