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, advertising expenditure and a cost-reducing investment. We find the conditions for complementarities among scale, advertising and innovation strategies to arise. In a duopoly with substitute products all variables are higher for the firm that moves from mass advertising to targeted advertising but decrease for the other. In an oligopoly with complementary products all variables are higher for all firms when they shift away from mass marketing. We conclude by linking our results to the empirical literature on internalization which finds a positive relationship between

. The paper studies the net effect of restructuring on retail prices and cost-reducing investment and discusses policy implications. JEL classification: D43, L43. Keywords: Access pricing; investment; double marginalization; vertical fore- closure; product differentiation. 1. INTRODUCTION It is widely believed that introducing competition is the key to achieving the full benefits of privatization in previously monopolized and regulated network industries, such as telecommunications, electricity or railways.1 The recent wave of ‘deregulation’ in these industries – i

(b) efficient firms face higher integration incentives. The driving force are demand/mark-up complementarities in the product market. While this observation is new in the context of vertical-integration decisions, similar mechanisms have been exploited in other fields. For instance, Bagwell and Staiger (1994) and Athey and Schmutzler (2001) use the related idea that cost-reducing investments are strategic substitutes in the context of many oligopoly models. Complementarities between demand-enhancing and mark-up-increasing activities are crucial for this result.32

, 117: 55-77. [33] Obara, I., (2001), “Private information in repeated games,” Ph. D. thesis. University of Pennsylvania. [34] Parreiras, S. (2005), “Correlated Information, mechanism design and in- formational rents,” Journal of Economic Theory, 123:210-217. [35] Persico, N., (2000), “Information acquisition in auctions,” Econometrica, 68:135-148. [36] Persico, N., (2004), “Committee design with endogenous information ”, Review of Economic Studies, 71:165—191. 25 Obara: The Full Surplus Extraction Theorem with Hidden Actions [37] Piccione, M and G. Tan, (1996), “Cost-reducing

investment stage. 6 Hence a firm’s investment xa is given by ps s n @gi @xi xa ðga þ nÞ2 1 ¼ 0 ð11Þ where ga :5 gi(xa, xa). 7 Implicit differentiation of (11) shows that investments under the GPS increase in the output price. Intuitively, for any given innovation yi a higher price induces more output [see (6)]. This makes cost- reducing investments more beneficial. Using (6) and (9), expected overall output is qaðpÞ :¼ E qi þ qjjxa ¼ 2p 1 sE yni jxa ¼ 2p 1 s ga ga þ n ð12Þ The effect of spillovers on investments and output depends on the characteristics of the

], (B.8) 3 0 0 Μ . S T A D L E R Für die isoelastische Nachfragefunktion p(Q) = S 1 / e Q - " e , S,e > 0 , ergibt sich aus (B.3) ein Preis (B.9) Ρ = r η - 1/ε (Β.10) und für die Gewinnfunktion in (B.5) ε — ( B . l l ) Literatur Dixit, Α. ( 1 9 8 6 ) , Comparative Statics for Oligopoly. International Economic Review 2 7 , Fersbtman, C., Muller, E. ( 1984) , Capital Accumulation Games of Infinite Duration. Journal of Economic Theory 3 3 , 3 2 2 - 3 3 9 . Flaherty, Μ. T. ( 1 9 8 0 a ) , Industry Structure and Cost-Reducing Investment. Econometrica 4 8

where the welfare implications, which differ from, for example, Cremer et al. (1991) and others, come from the welfare-maximizing price regulation, not from a location subgame. However, with endogenous production costs, privatization of the public firm would improve welfare compared with a mixed duopoly because it would mitigate the loss arising from excessive cost-reducing investments of the private firm (Matsumura and Matsushima, 2004). In price-regulated markets such as the hospital industry, firms rather compete in quality or location than in prices (Brekke, 2004