Outsourcing and Vertical Integration in a Competitive Industry

We develop a partial equilibrium, perfectly competitive framework of a (potentially) vertically integrated industry. There are three types of firms: upstream firms that use primary factors to produce an intermediate good; downstream firms that use primary factors and intermediate goods to produce a final good; and vertically integrated firms that do both. We establish conditions under which vertically integrated firms exist and outsource (part of) the production of the intermediate input. We study the changes in industry configurations resulting from changes in costs and demand.