United States Naval Academy Mergers with Quality Differentiated Goods

We consider the impact of merger on the equilibrium price and quality of products. Consumer demand for both products depends not only on own price and quality, but also on the price and quality of the other product. We consider both the case in which the merging firms produce gross complements, and the case in which the firms produce gross substitutes. In both cases, merger may lower or increase both product price and quality. In the case in which firms produce complementary products, it may happen that firms both lower price and increase product quality when merged. This happens when the cross quality elasticities of demand and the cross price elasticities of demand are equal in magnitude. Surprisingly, we also find that there are situations under which merger between firms producing substitutes increases welfare. For example, it is possible that merger between firms producing gross complements may result in higher product quality but lower social welfare, and merger between firms producing substitute products may result in lower product quality but higher social welfare.