This research investigates the endogenous choice of prices versus quantities in a vertically-related market where an integrated firm competes with a downstream firm and they bargain over a two-part tariff input pricing contract. Contrary to the standard result, we show that both Bertrand competition and Cournot competition can be sustained as equilibrium outcomes. First, the Bertrand equilibrium maximizes industry profit, but there is a market failure in the choice of the type of strategic variables. Second, the Cournot equilibrium maximizes social welfare and consumer surplus, but there is a prisoners' dilemma. This paper ends with an extension, showing that our baseline model arises naturally as the equilibrium outcome of a simple game that admits vertical mergers.
