Perfect Competition and Organizational Inefficiencies∗

We construct a price-theoretic model of integration decisions and show that these choices may adversely affect consumers, even in the absence of monopoly power in supply and product markets. Integration is costly to implement but is effective at coordinating production decisions. The price of output helps to determine the organizational form chosen: there is an inverted-U relation between the degree of integration and product prices. Moreover, organizational choices affect output: integration is more productive than nonintegration at low prices, and less productive at high prices. Since shocks to industries affect product prices, reorganizations are likely to take place in coordinated fashion and be industry specific, consistent with the evidence. Since the price range in which integration maximizes productivity generally differs from the one in which it maximizes managerial welfare, organizational choices will often be second-best inefficient. We show that there are instances in which entry of low-cost suppliers can hurt consumers by changing the terms of trade in the supplier market, thereby inducing reorganizations that raise prices. ∗Some of the material in this paper circulated in an earlier paper under the title “ Managerial Firms, Organizational Choice, and Consumer Welfare.” We thank Roland Benabou, Patrick Bolton, Phil Bond, Estelle Cantillon, Paola Conconi, Jay Pil Choi, Mathias Dewatripont, Robert Gibbons, Oliver Hart, Georg Kirchsteiger, Giovanni Maggi, Armin Schmuckler, and George Symeonidis for helpful discussion. Legros benefited from the financial support of the Communauté Française de Belgique (projects ARC 98/03-221 and ARC00/05-252), and EU TMR Network contract nFMRXCT98-0203. Newman was the Richard B. Fisher Member of the Institute for Advanced Study, Princeton when some of the research for this paper was conducted. †ECARES, Université Libre de Bruxelles, and CEPR. ‡Boston University and CEPR.