Abstract
This chapter discusses the impact of vertical integration in an oligopolistic setting with a focus on the relations between the subgame perfect Nash equilibrium and the possibility of substitution among intermediate inputs. The results show that the substitutability of intermediate inputs, represented by a CES production function in the downstream industry, does not change the basic conclusion, which states that vertical integration is welfare-enhancing because the output quantity of the final goods increases and the final price falls. After considering the three generic vertical structures of market transactions, supply contracts and full integration, the formulae of the derived demand elasticity for the intermediate inputs have been derived and compared. It has been found that the derived demand of the downstream firms is more elastic under supply contracts than under market transactions. The reason is that the strategic interactions among the Cournot-behaved downstream firms increase the elasticity of the demand for intermediate inputs.
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