The Competitiveness of Upstream Markets with Vertically Integrated Firms∗

We analyze price competition between vertically integrated firms which inter-act on a downstream and an upstream markets. The upstream market allows downstream-only firms to buy inputs needed to compete on the final market. The upstream product offered by the vertically integrated firms is perfectly homogenous whereas the downstream market is differentiated. The setting is relevant to analyze the role of upstream markets in network industries, the licensing of (substitute) innovations or patents to potential rivals in oligopolistic markets, or the impact of resale markets. As common sense suggests, there always exists an equilibrium in which upstream prices are equal to the unit cost of providing the intermediate product. However, even in a static framework, two other equilibria appear: one in which the upstream market becomes endogenously monopolistic, and another one in which vertically integrated firms set identical prices strictly larger than their average cost but strictly smaller than the joint profit-maximizing upstream price. In light of these results, we then examine the determinants of the competitiveness of the upstream markets. An application to the analysis of wholesale markets in telecommunications is proposed