Vertical Separation and Integration in a Utility Industry Where Entrants Invest to Reduce Cost Disadvantages

This paper compares the effects of vertical separation and integration in a utility industry where entrants in a competitive sector invest to reduce cost disadvantages. In utility industries, natural monopolistic and competitive activities are vertically related. Under vertical integration, the incumbent in the competitive sector possesses an essential network facility in the natural monopolistic sector. On the other hand, under vertical separation, the third-party operator holds. Further, the access price for using the essential network facility is regulated. We show that the optimal access price levels under vertical separation and integration depend on the number of entrants and the degree of the cost-reducing effect of each entrant\u27s investment. We also show that whether vertical separation holds a welfare advantage over vertical integration depends on the number of entrants, the degree of the cost-reducing effect of each entrant\u27s investment, and the optimal access price level