Horizontal Mergers With One Capacity Constrained Firm Increase Prices ∗ David J. Balan Bureau of Economics Federal Trade Commission 600 Pennsylvania Ave NW Mail Drop HQ-286 Washington, DC 20580 dbalan@ftc.gov Patrick DeGraba Bureau of Economics Federal Trade Commission 600 Pennsylvania Ave NW Mail Drop HQ-286 Washington, DC 20580 pdegraba@ftc.gov Jason O’Connor Bureau of Economics Federal Trade Commission 600 Pennsylvania Ave NW Mail Drop HQ-286 Washington, DC 20580 joconnor@ftc.gov Apri 16, 2018 Abstract It is often claimed that horizontal mergers cannot cause price increases if one of the merging firms is capacity constrained. The argument is that the constraint prohibits the post-merger recapture of lost sales, and thereby disables the mechanism by which merger-induced price increases occur. In this paper we show that this claim is incorrect. We show that mergers between substitutes in which one of the merging firms faces a binding pre-merger capacity constraint unambiguously increase prices in a price-setting Stackelberg game. The intuition is simple. Even if there is no recapture of lost sales, a merger causes the acquiring entity to take into account the positive effect of a change in the price of its good on the price of the acquired good. If the constraint continues to bind in the post-merger equilibrium, this reduces to the fact that an increase in the price of the unconstrained good increases the price at which the constrained good sells out its capacity. We also show a similar result for a Cournot quantity-setting game. These results points to the danger of focusing only on lost sales, and ignoring the internalization of higher prices. JEL Classification Codes: L13, L40. Keywords: Capacity constraints, horizontal mergers, Upward Pricing Pressure, UPP. * We would like to thank Daniel O’Brien, Ted Rosenbaum, and especially David Schmidt for helpful comments and discussion. The views expressed in this article are those of the authors and do not necessarily reflect those of the Federal Trade Commission.