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
Pepall et al. (2014, pp. 222–228)
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?
Static and dynamic games Entry deterrence and predation
Stackelberg model
Pepall et al. (2014, pp. 265–268)
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?
Static and dynamic games Entry deterrence and predation
Stackelberg model – graph
Static and dynamic games Entry deterrence and predation
Limit output and limit price models
Pepall et al. (2014, pp. 289–291)
Stackelberg + the follower has one-time sunk entry costs F.
What quantity qd
L would deter entry?
Static and dynamic games Entry deterrence and predation
Limit output and limit price models
Pepall et al. (2014, pp. 289–291)
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. (2014, pp. 291–299)
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
Static and dynamic games Entry deterrence and predation
The incumbent’s best response in stage 2
Static and dynamic games Entry deterrence and predation
The rational bounds on the incumbent’s choice of K1
Static and dynamic games Entry deterrence and predation
Possible locations of the entrant’s break-even point
Static and dynamic games Entry deterrence and predation
Evidence on predatory capacity expansion
Pepall et al. (2014, pp. 304–309)
• Alcoa case – increased capacity 8x between 1912 and 1934
• Weiman and Levin (1994) – preemptive investment in SBT
• Safeway in Edmonton in 1960s and 1970s
• DuPont production of titanium dioxide
• Excess capacity expansion in Texas hotels