Horizontal mergers and Cournot competition

Study Notes

Horizontal mergers involve companies at the same level in the supply chain combining to form a single entity.
Decision factors include the potential impacts on efficiency, pricing strategies, and competition authorities' scrutiny.

Coordinated actions by firms can maximize overall profits but may ignore externalities that impact other firms.
For example, a firm's production increase may negatively affect its competitors' profits.

Quantity Competition: Firms compete by choosing how much to produce. If one firm increases output, it can harm others, leading to strategic substitutes.
Price Competition: Firms set prices instead. A price increase by one firm could benefit others, resulting in strategic complements.

Coordination in quantity competition results in lesser negative impacts on consumers than in price competition.
Price coordination generally leads to higher prices and more significant consumer harm.

Consumers aim to maximize utility based on quantities produced by firms.
Firms respond to each other's output in a way that considers cost and demand, leading to best-response functions.

Achieved when firms' reaction functions intersect, indicating that no firm can benefit by unilaterally changing its output.
Equilibrium involves both firms choosing quantities where their total output optimally matches market demand.

In settings with multiple firms with varying costs:
- Aggregated production equals the sum of individual outputs.
- Nash equilibrium extends to assess the impact of each firm’s marginal costs on overall market output and pricing.

With an increase in the number of firms, competitive pressure rises, often leading to lower equilibrium prices.
The presence of more firms typically results in fewer profits per individual firm, depending on their costs and production behavior.### Mergers Between Firms
Demand for firms with homogeneous products follows a linear model.
Firms assume constant marginal costs in a Cournot competition setting.
Seven firms considering merging (range: 2 to 9 firms).
Merging does not create efficiency gains; firms remain symmetric post-merger.

Number of active firms before merger: 9.
After merger: 9 - non-merged firms + merged entity, resulting in a decrease in active firms.

Analyze profits of merged entity before and after the merger.
Important to compare total profits of merging firms before the merger.
“80% Rule”: Mergers are only profitable if they involve at least 80% of firms in the market.
Profitability relies on the balance between reduced production quantity and reactions from outside firms.

Synergies arise from operational rationalization, resulting in lower marginal costs for the merged entity.
Marginal cost before merger: uniform across firms; after merger, varies with non-merging firms maintaining higher costs.
Mergers are profitable if they lead to significant cost synergies without creating a highly concentrated market.

In a scenario with three firms considering a merger, initial Nash Equilibrium (NE) profits are calculated pre-merger.
Post-merger calculations yield different outputs and profits, dependent on the degree of synergies.
For a merger to increase consumer surplus, the new pricing conditions must favor consumers.

Total surplus criterion combines consumer surplus and total profit from both insiders and outsiders.
Merger approval hinges on the condition that overall changes in total surplus must be positive.
Efficiency gains can counterbalance the adverse effects of reduced competition from mergers.

Mergers that create efficiencies without excessive market concentration can benefit total welfare.
When mergers lead to high market concentration, they can be profitable while still harming consumers or overall social welfare.

Price competition differs from quantity competition, featuring positive externalities.
If a firm raises prices, profits for other firms may rise too, resulting in upward-sloping reaction functions.
Without efficiency gains, mergers might be welfare-detrimental despite being profitable due to price adjustments in the market.