Competitive vertical integration

In the bilateral monopoly case, optimality is a necessary condition so that vertical integration is a noncooperative equilibrium: the combined profits of upstream and downstream firms rise with merger. On the other hand, with a bilateral duopoly where the firms decide to merge vertically sequentially, optimality is not a necessary condition of a noncooperative equilibrium. Combined upstream and downstream profits may decrease with vertical integration. Our case is of Prisoner's Dilemma type. Each downstream firm tries to secure unilaterally a cost advantage by merging vertically. As every downstream firm follows this strategy, all outputs increase with a negative impact upon market price and profits.