COMPETITION AND REGULATION IN VERTICALLY RELATED MARKETS

In an industry where naturally monopolistic and competitive activities are vertically related, should the natural monopolist be allowed also to operate in the deregulated competitive sector? Unlike much of the literature on vertical integration, this paper assumes that monopoly pricing behaviour is regulated, and therefore the effect of vertical integration on the task of regulation is central to the analysis. In the model there is both imperfect information and imperfect competition. When vertical integration by the monopolist is allowed, the regulator's task is made harder insofar as the monopolist has anticompetitive incentives to raise rivals' costs. On the other hand, integration may lead to there being fewer firms in the deregulated sector and hence less duplication of fixed costs. The overall welfare comparison between separation and integration is ambiguous, as two simple examples illustrate. Various extensions to the analysis are also considered.