Static and dynamic games Entry deterrence and predation Static and dynamic games, preventing the entry and predation Industrial organization – lecture 2 Static and dynamic games Entry deterrence and predation Cournot model 2 firms with • the same marginal cost c1 = c2 = c • zero fixed cost F1 = F2 = 0 Inverse demand function: p = A − (q1 + q2) What is the Cournot equilibrium? What is the profit? What happens if firms have positive fixed costs? Static and dynamic games Entry deterrence and predation Stackelberg model Pepall et al. (2010, p. 193) 2 firms: • firm 1 is the leader • firm 2 is the follower Both firms have • the same marginal cost c1 = c2 = c • zero fixed cost F1 = F2 = 0 Inverse demand function: p = A − (q1 + q2) What is the Stackelberg equilibrium? What is the profit? What is the reason for the dominance of the leader? What happens if firms have positive fixed costs? Static and dynamic games Entry deterrence and predation Limit output and limit price models Pepall et al. (2010, pp. 193–195) We assume that the follower has one-time sunk entry costs F. What quantity qd L would deter entry? When does the leader choose the quantity qd L ? Static and dynamic games Entry deterrence and predation Capacity expansion as a credible entry-deterring commitment Pepall et al. (2010, pp. 195–202) Dixit, A. (1980). The role of investment in entry-deterrence. The economic journal, 90(357), 95–106. A dynamic two-stage game between two firms: 1. The incumbent chooses the capacity level K1 at a cost rK1. 2. Cournot game: The incumbent’s costs are c1(q1) = wq1 + rK1 + F1 for q1 ≤ K1 (w + r)q1 + F1 for q1 > K1 The entrant’s costs are c2(q2) = (w + r)q2 + F2 Static and dynamic games Entry deterrence and predation The effect of previously acquired capacity Pepall et al. (2010, p. 197) Static and dynamic games Entry deterrence and predation The incumbent’s best response in stage 2 Pepall et al. (2010, p. 197) Static and dynamic games Entry deterrence and predation The rational bounds on the incumbent’s choice of K1 Pepall et al. (2010, p. 199) Static and dynamic games Entry deterrence and predation Possible locations of the entrant’s break-even point Pepall et al. (2010, p. 200) Static and dynamic games Entry deterrence and predation Evidence on Predatory Capacity Expansion Pepall et al. (2010, pp. 203–204) • Alcoa case – increased capacity 8x between 1912 and 1934 • Weiman and Levin (1994) – preemptive investment in SBT • Safeway in Edmonton in 1960s and 1970s • DuPontand production of titanium dioxide • Take-or-pay contract – a way to commit to a quantity Static and dynamic games Entry deterrence and predation Asymmetric information and limit pricing Pepall et al. (2010, pp. 206–211) Milgrom, P., Roberts, J. (1982). Predation, reputation, and entry deterrence. Journal of economic theory, 27(2), 280-312. Microhard may be high-cost or low-cost – two period game: 1. Microhard M chooses high or low price 2. Newvel N may enter or stay out