Does structure dominate regulation? The case of an input monopolist

1I would like to thank seminar participants at the University of Melbourne and the University of Sydney for their helpful comments. This paper constructs a simple repeated game model to analyze how industry outcomes alter if a regulated input monopolist is allowed to integrate into the downstream retail market. Integration helps overcome double marginal-ization — a feature well known in the existing literature. Unlike existing static models, however, integration also makes tacit collusion more difficult in a repeated game framework. If the regulated input price exceeds marginal cost, an integrated monopolist has an incentive to increase retail sales as this raises upstream profits. It will be less willing to engage in any tacitly collu-sive conduct in the downstream market and it has a greater incentive to cheat on any collusive arrangement. We show that these effects may dominate in-put price regulation. A social planner may prefer the upstream monopoly to participate in the downstream market, even if integration leads to a higher regulated input price. The anti-competitive effects of the higher input price are more than offset by the pro-competitive effects of integration.