Internal versus External Growth in Industries with Scale Economies: A Computational Model of Optimal Merger Policy ∗ PRELIMINARY AND INCOMPLETE Ben Mermelstein Northwestern University Volker Nocke University of Mannheim and CEPR Mark Satterthwaite Northwestern University Michael D. Whinston Northwestern University and NBER September 17, 2012 Abstract We study optimal merger policy in a dynamic model in which the presence of scale economies imply that firms can reduce costs through either internal investment in building capital or through mergers. The model, which we solve computationally, allows firms to invest or propose mergers according to the relative profitability of these strategies. An antitrust authority is able to block mergers at some cost. We examine the optimal policy when the antitrust can commit to a policy rule and when it cannot commit, and consider both consumer value and aggregate value as possible objectives fo the antitrust authority. We find that optimal policy can differ substantially from what would be optimal considering only welfare in the period the merger is proposed. We also find that the ability to commit can lead to a significant welfare improvement. In general, firms’ optimal investment behavior can be greatly affected by the antitrust policy, and the optimal policy (absent commitment) can in turn be greatly affected by firms’ investment behavior. ∗ We thank Alan Collard-Wexler, Gautam Gowrisankaran, and Ariel Pakes as well as seminar audiences at NYU and the 2012 “Dynamic Models in IO” conference at SciencesPo, Paris for their comments. Whinston thanks the National Science Foundation and the Toulouse Network for Information Technology for financial support.