Outsourcing, vertical integration, and price vs. quantity competition

Abstract

We show that standard conclusions about duopoly competition can be reversed when the production of key inputs is outsourced to a vertically integrated retail competitor with upstream market power. Under such outsourcing, Bertrand competition can produce higher prices, higher industry profit, lower consumer surplus, and lower total surplus than Cournot competition. In addition to limiting the intensity of retail competition, Bertrand competition can limit the extent of wholesale competition by reducing the incentive of retail providers to produce key inputs themselves.