Staff Report 264

Do Mergers Lead to Monopoly in the Long Run? Results From the Dominant Firm Model

Thomas J. Holmes | University of Minnesota, Federal Reserve Bank of Minneapolis
Gautam Gowrisankaran

Published March 1, 2000

Will an industry with no antitrust policy converge to monopoly, competition or somewhere in between? We analyze this question using a dynamic dominant firm model with rational agents, endogenous mergers and constant returns to scale production. We find that perfect competition and monopoly are always steady states of this model and that there may be other steady states with a dominant firm and a fringe co-existing. Mergers are likely only when supply is inelastic or demand is elastic, suggesting that the ability of a dominant firm to raise price through monopolization is limited. Additionally, as the discount rate increases, it becomes harder to monopolize the industry, because the dominant firm cannot commit to not raising prices in the future.

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