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Forward induction and the excess capacity puzzle: An experimental investigation

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Author Info
Jordi Brandts (Instituto de Análisis Económico)
Antonio Cabrales (Universitat Pompeu Fabra)
Gary Charness (Economics Department, University of California, Santa Barbara)

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Abstract

While the theoretical industrial organization literature has long argued that excess capacity can be used to deter entry into markets, there is little empirical evidence that incumbent firms effectively behave in this way. Bagwell and Ramey (1996) propose a game with a specific sequence of moves and partially-recoverable capacity costs in which forward induction provides a theoretical rationalization for firm behavior in the field. We conduct an experiment with a game inspired by their work. In our data the incumbent tends to keep the market, in contrast to what the forward induction argument of Bagwell and Ramey would suggest. The results indicate that players perceive that the first mover has an advantage without having to pre-commit capacity. In our game, evolution and learning do not drive out this perception. We back these claims with data analysis, a theoretical framework for dynamics, and simulation results.

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Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number 15-03.

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Date of creation: 27 Aug 2003
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Handle: RePEc:cdl:ucsbec:15-03

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Keywords: entry excess capacity forward induction equilibrium selection first-mover advantage

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  1. Battigalli, Pierpaolo, 1996. "Strategic Rationality Orderings and the Best Rationalization Principle," Games and Economic Behavior, Elsevier, vol. 13(2), pages 178-200, April. [Downloadable!] (restricted)
  2. Cooper, Russell & Douglas V. DeJong & Robert Forsythe & Thomas W. Ross, 1993. "Forward Induction in the Battle-of-the-Sexes Games," American Economic Review, American Economic Association, vol. 83(5), pages 1303-16, December. [Downloadable!] (restricted)
  3. R. Muller & Asha Sadanand, 2003. "Order of Play, Forward Induction, and Presentation Effects in Two-Person Games," Experimental Economics, Springer, vol. 6(1), pages 5-25, June. [Downloadable!] (restricted)
  4. Mason, Charles F. & Nowell, Cliff, 1998. "An experimental analysis of subgame perfect play: the entry deterrence game," Journal of Economic Behavior & Organization, Elsevier, vol. 37(4), pages 443-462, December. [Downloadable!] (restricted)
  5. van Damme, Eric, 1989. "Stable equilibria and forward induction," Journal of Economic Theory, Elsevier, vol. 48(2), pages 476-496, August. [Downloadable!] (restricted)
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  6. Kyle Bagwell, 1992. "Commitment and Observability in Games," Discussion Papers 1014, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
  7. Franco Modigliani, 1958. "New Developments on the Oligopoly Front," Journal of Political Economy, University of Chicago Press, vol. 66, pages 215. [Downloadable!] (restricted)
  8. Smiley, Robert, 1988. "Empirical evidence on strategic entry deterrence," International Journal of Industrial Organization, Elsevier, vol. 6(2), pages 167-180. [Downloadable!] (restricted)
  9. Van Huyck John B. & Battalio Raymond C. & Beil Richard O., 1993. "Asset Markets as an Equilibrium Selection Mechanism: Coordination Failure, Game Form Auctions, and Tacit Communication," Games and Economic Behavior, Elsevier, vol. 5(3), pages 485-504, July. [Downloadable!] (restricted)
  10. Huck, Steffen & Muller, Wieland, 2000. "Perfect versus Imperfect Observability--An Experimental Test of Bagwell's Result," Games and Economic Behavior, Elsevier, vol. 31(2), pages 174-190, May. [Downloadable!] (restricted)
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  11. Dixit, Avinash, 1980. "The Role of Investment in Entry-Deterrence," Economic Journal, Royal Economic Society, vol. 90(357), pages 95-106, March. [Downloadable!] (restricted)
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  12. Singh, Satwinder & Utton, Michael & Waterson, Michael, 1998. "Strategic behaviour of incumbent firms in the UK," International Journal of Industrial Organization, Elsevier, vol. 16(2), pages 229-251, March. [Downloadable!] (restricted)
  13. Schotter Andrew & Weigelt Keith & Wilson Charles, 1994. "A Laboratory Investigation of Multiperson Rationality and Presentation Effects," Games and Economic Behavior, Elsevier, vol. 6(3), pages 445-468, May. [Downloadable!] (restricted)
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  14. Hauk, Esther & Hurkens, Sjaak, 2002. "On Forward Induction and Evolutionary and Strategic Stability," Journal of Economic Theory, Elsevier, vol. 106(1), pages 66-90, September. [Downloadable!] (restricted)
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  15. Borgers, Tilman & Sarin, Rajiv, 1997. "Learning Through Reinforcement and Replicator Dynamics," Journal of Economic Theory, Elsevier, vol. 77(1), pages 1-14, November. [Downloadable!] (restricted)
  16. Cooper, Russell & De Jong, Douglas V. & Forsythe, Robert & Ross, Thomas W., 1992. "Forward induction in coordination games," Economics Letters, Elsevier, vol. 40(2), pages 167-172, October. [Downloadable!] (restricted)
  17. Cabrales, Antonio, 2000. "Stochastic Replicator Dynamics," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(2), pages 451-81, May.
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  18. Brandts, Jordi & Holt, Charles A., 1995. "Limitations of dominance and forward induction: Experimental evidence," Economics Letters, Elsevier, vol. 49(4), pages 391-395, October. [Downloadable!] (restricted)
  19. Kyle Bagwell & Garey Ramey, 1996. "Capacity, Entry, and Forward Induction," RAND Journal of Economics, The RAND Corporation, vol. 27(4), pages 660-680, Winter. [Downloadable!] (restricted)
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  20. Balkenborg, Dieter, 1994. "An Experiment on Forward- versus Backward Induction," Discussion Paper Serie B 268, University of Bonn, Germany.
  21. Geroski, P. A., 1995. "What do we know about entry?," International Journal of Industrial Organization, Elsevier, vol. 13(4), pages 421-440, December. [Downloadable!] (restricted)
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