Suppose that a manufacturer and its retailer both operate as a market monopoly. The retailer experiences no transaction cost for buying form the manufacturer, and the marginal cost of manufacturing is constant at 2. Market demand for the manufactured product is p=10-q

(a) How much would the manufacturer and the retailer charge if they operate separately? Calculate their individual and joint profits.

(b) Based on your answers to (a), explain what Double Marginalization is.

(c) If the manufacturer and the retailer merge, how much would the vertically integrated firm charge the consumers? Calculate the profit and the Lerner Index of the integrated firm.

(d) Quantify the welfare improvement due to vertical integration. What is your intuition that welfare improves in this scenario?