Buyer power with atomistic upstream entry: Can downstream consolidation increase production and welfare?

- We model entry into an upstream industry under downstream oligopsony.
- The upstream industry is atomistic and the downstream sector is concentrated.
- Buyers make early purchase commitments and later hold up sunk upstream investments.
- Buyer concentration can increase upstream entry and social welfare.
- We characterize occurrences of this puzzle using relevant market parameters.

This paper investigates the effects of buyer power on entry into an atomistic upstream market and economic welfare. Under reasonable market conditions, we show that industries with a few buyers induce more upstream entry than industries with a larger number of firms. In particular, monopsony can be more conducive to entry and lead to higher social welfare than more fragmented industry structures. This seeming paradox arises because a single buyer better internalizes the positive effects of entry on later-periods' supply conditions than a collection of firms. This result is relevant in a number of market settings, including markets for specialized labor and processing markets for agricultural products.