Vertical Integration, Contestable Markets, and the Misfortunes of the Misshaped,

This paper models the vertical integration of an 'upstream' monopolist who sells an 'intermediate' good to firms in a contestable 'downstream' market. The downstream firms combine that good with other inputs--according to a production function with U-shaped average costs--to produce a 'final' good which is sold to consumers at minimum average cost. The paper has two main themes. The first is to compare the incentives for and results of vertical integration in the case where the upstream market is protected from entry with those in the case where the upstream market is contestable. The results suggest that vertical mergers should be encouraged in the latter case but tolerated in the former only under specific guidelines.