CAPACITY CONSTRAINT, MERGER PARADOX AND WELFARE-IMPROVING PRO-MERGER POLICY

• Published in: Hitotsubashi journal of economics Vol. 57; no. 1; pp. 1 - 26
• Main Authors: Dong, Baomin, Guo, Guixia, Qian, Xiaolin, Wang, Frank Yong
• Format: Journal Article
• Language: English
• Published: Hitotsubashi University 01-06-2016
• Subjects: Capacity costs; Industrial policy; Investment policy; Investment subsidies; Oligopolies; Paradoxes; Profitable firms; Social welfare; Subsidies; We they distinction
• ISSN: 0018-280X
• DOI: 10.15057/27944

In this paper, we show that the "Merger Paradox" (Salant, Switzer and Reynolds, 1983) is mitigated when capacity constraint is considered. This is because outside firms who do not participate in a merger cannot expand their output beyond their existing capacity, and therefore, Stigler type of free riding is alleviated. When overcapacity is socially costly, it is also shown that a pro-merger fiscal policy may discourage ex ante capacity investment and hence alleviate overcapacity, if capacity building is not too costly. Furthermore, it can be shown that the optimal pro-merger subsidy is always welfare improving when it discourages capacity building.