This paper studies the welfare effects of location space constraints when the duopoly sellers are vertically separated. As the downstream firms respond to higher input prices by locating further away from the center of the market, constraining them to locate within the linear city allows the upstream manufacturers better to exploit the downstream industry. This leads to higher final good prices and lower consumer welfare (despite the savings on transportation). This result – which is robust to the inclusion of R&D decisions – is in sharp contrast to the case in which the sellers are vertically integrated. Also different, the incentive to invest in cost-reducing R&D is always insufficient compared with the social optimum. Our results thus suggest the importance of taking into account the vertical market structure in formulating zoning (product standard) and R&D policies.
Location constraint R&D Vertical separation
L1 R3 D4
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We are indebted to the editor, Lawrence J. White, for many valuable comments and suggestions. We also wish to thank two anonymous referees and participants at the Industrial Organization Theory Workshop at Shandong University and the Industrial Organization and International Trade Workshop at Jinan University for helpful comments. Financial support from the National Science Foundation of China (71603083, 71603283) is gratefully acknowledged. The usual disclaimers apply.
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