The Emergence of Intermediate Markets and Social Welfare

The paper examines the welfare effects of the development of an intermediate market. For this purpose I develop a model where such a market may arise endogenously. If integrated and unintegrated firms coexist in equilibrium, consumers do not benefit from the emergence of an intermediate market. Under free entry into the final-good market all additional surplus accrues to the intermediate-good suppliers as profits. However, if entry into the whole industry is free, profits are eroded and scale economies are destroyed. From a social standpoint, entry into the intermediate market is excessive.