Working Paper: CEPR ID: DP2280
Authors: Gene M. Grossman; Elhanan Helpman
Abstract: We develop an equilibrium model of industrial structure in which the organization of firms is endogenous. Differentiated consumer products can be produced either by vertically integrated firms or by pairs of specialized companies. Production of each variety of consumer good requires a unique, specialized component. Vertically integrated firms can manufacture the components they need in the quantity and type that maximizes profits, but they face a relatively high cost of governance. Specialized firms can produce at lower cost, but input suppliers face a potential hold-up problem. We study the equilibrium mode of organization when inputs are fully or partially specialized. We consider how the degree of competition in the market and other parameters affect the equilibrium choices, and how the equilibrium compares with the efficient allocation.
Keywords: Vertical Integration; Holdup Problem; Input Specificity
JEL Codes: D23; D43; D51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased competition (L13) | higher probability of specialized pairs being the optimal organizational choice (L29) |
| higher fixed costs (L11) | push the market towards specialization (D40) |
| specialized pairs equilibrium (D50) | greater consumer welfare (D69) |
| vertically integrated firms (L22) | higher production costs due to governance issues and lack of specialization (D20) |