Recycling of Waste: Competition and Extended Producer Responsibility Induced Vertical Integration

Abstract We develop a two-period model of a vertically related market with two firms and a recycler. The manufacturer can restrict recycler’s capacity by lowering output, since the recycler uses its scrap to compete in the input market. We assume the recycler is more efficient, producing at lower unit cost. Market outcomes depend on the recycler’s collection rate and relative efficiency. If the collection rate is high and efficiency advantage is moderate, an unconstrained equilibrium arises where the recycler operates at optimal capacity; otherwise, constrained equilibrium prevails. Welfare outcomes differ accordingly. With low efficiency, partial recycling, which allows the recycler to produce freely, maximizes welfare. With very high efficiency, however, complete recycling is optimal. Vertical integration between the final good producer and recycler is not chosen voluntarily. Extended producer responsibility–induced integration is optimal only under constrained equilibrium with low recycling rate, or under unconstrained equilibrium with moderate efficiency. The results are also robust to alternative modes of competition and contract structures.