Welfare implications of subsidy and contract type in a vertically related industry

Abstract

Here we analysis several issues that are concerned with a vertically related industry. First, we examine the effect of subsidy from an upstream firm to a downstream firm on consumer welfare. It depends on the competition mode after subsidy is given. Price is lower for the where subsidy is reflected through the reduction in unit cost price competition prevails than the case where non-price competition like bonus presents provision entails by subsidy. Second, if subsidy is given with the constraint of long-term contract, then social welfare may go down with this kind of subsidy. This is due to the fact that a downstream firm may have to maintain the relation with a less efficient upstream firm. Third, the effect of vertical integration on consumer welfare is different according to the initial type of contract between an upstream firm and a downstream firm. When there was a free contract between them at the beginning, the consumer welfare may go down after integration. When there was a exclusive long term contract, the consumer welfare can rise by integration.