The main public policy issue raised by merger activity is its potential to reduce competition. Between 1890 and the 1960s, strict laws were passed to prevent mergers that reduced competition or created monopolies. Subsequently, a different view of mergers developed, based on the idea that mergers may improve productive efficiency. In response to these new ideas, the United States revised its guidelines on merger activity, so that before approving a merger, the anti-trust body should compare the loss from reduced competition with any efficiency gains. Therefore, much effort in litigation cases is devoted to establishing feasible criteria for comparing the anti-competitive effects of different mergers.

In Discussion Paper No. 1517, Ramon Fault-Oller constructs a theoretical model which conforms to the two implications of merger guidelines: a low elasticity of demand, which implies a loss of welfare with mergers; and mergers of a given size reduce welfare more, the greater the degree of market concentration. The paper yields two important findings. First, elasticity performs poorly as a predictor of anti-competitive effects. Second, another important element is supply substitution, i.e. where the ability to raise price by reducing output is further limited by the possibility that competitors may raise their output. Unfortunately, because supply substitution is not directly observable, no general policy recommendations can be derived from these results, although the author does find cases in which supply substitution can be calculated using available information on the elasticity of demand.

Mergers for Market Power in a Cournot Setting and Merger Guidelines
Ramon Fault-Oller