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Endogenous Capacities and Price Competition: The Role of Demand Uncertainty

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  • de Frutos, Maria-Angeles
  • Fabra, Natalia

Abstract

This paper analyzes a model of capacity choice followed by price competition under demand uncertainty. Under various assumptions regarding the nature and timing of demand realizations, we obtain general predictions concerning the role of demand uncertainty on equilibrium outcomes. We show that it reduces the multiplicity of equilibria, it may rule out the existence of symmetric equilibria, and it leads to endogenous capacity asymmetries even though firms are ex-ante symmetric. Furthermore, as compared to the certainty equivalent game, demand uncertainty reduces prices and increases consumer surplus, but it also decreases total welfare because of the emergence of idle capacity. By relying on the analysis of firms' reaction functions as well as on the theory of submodular games, we are able to show that a subgame perfect equilibrium always exists and to fully characterize it.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6096.

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Date of creation: Feb 2007
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Handle: RePEc:cpr:ceprdp:6096

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Keywords: demand uncertainty; investment; price competition; submodular game;

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References

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Citations

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Cited by:
  1. Ruderer, D., 2012. "The Impact of Transmission Pricing in Network Industries," Cambridge Working Papers in Economics 1230, Faculty of Economics, University of Cambridge.
  2. Sakellaris, Kostis, 2010. "Modeling Electricity Markets as Two-Stage Capacity Constrained Price Competition Games under Uncertainty," MPRA Paper 23317, University Library of Munich, Germany.
  3. de Frutos, María-Ángeles & Fabra, Natalia, 2011. "Endogenous capacities and price competition: The role of demand uncertainty," International Journal of Industrial Organization, Elsevier, vol. 29(4), pages 399-411, July.
  4. Peña, Juan Ignacio, 2011. "Las emisiones primarias de energía en el mercado español: valoración de opciones teórica y de mercado/Primary Energy Emissions in the Spanish Market: Theoretical and Market-Based Option Pricing," Estudios de Economía Aplicada, Estudios de Economía Aplicada, vol. 29, pages 617-626, Agosto.
  5. Charalambos Christou & Rossitsa Kotseva & Nikolaos Vettas, 2009. "Pricing, Investments and Mergers with Intertemporal Capacity Constraints," Discussion Paper Series 2009_06, Department of Economics, University of Macedonia, revised Mar 2009.
  6. Christou, Charalambos & Kotseva, Rossitsa & Vettas, Nikolaos, 2007. "Pricing, Investments and Mergers with Intertemporal Capacity Constraints," CEPR Discussion Papers 6433, C.E.P.R. Discussion Papers.
  7. Tasnádi, Attila, 2012. "Endogenous Timing of Moves in Bertrand-Edgeworth Triopolies," MPRA Paper 47610, University Library of Munich, Germany.
  8. Lepore, Jason J., 2012. "Cournot outcomes under Bertrand–Edgeworth competition with demand uncertainty," Journal of Mathematical Economics, Elsevier, vol. 48(3), pages 177-186.
  9. Kalyan Talluri & Víctor Martínez de Albéniz, 2010. "Dynamic price competition with fixed capacities," Economics Working Papers 1205, Department of Economics and Business, Universitat Pompeu Fabra.
  10. Robert Somogyi, 2013. "Bertrand-Edgeworth competition with substantial product differentiation," IEHAS Discussion Papers 1332, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.
  11. Grimm, Veronika & Martin, Alexander & Weibelzahl, Martin & Zöttl, Gregor, 2014. "Transmission and Generation Investment in Electricity Markets: The Effects of Market Splitting and Network Fee Regimes," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 460, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  12. Kalyan Talluri & Víctor Martínez de Albéniz, 2010. "Dynamic Price Competition with Fixed Capacities," Working Papers 425, Barcelona Graduate School of Economics.
  13. Grimm, Veronika & Martin, Alexander & Weibenzahl, Martin & Zoettl, Gregor, 2014. "Transmission and generation investment in electricity markets: The effects of market splitting and network fee regimes," IWQW Discussion Paper Series 04/2014, Friedrich-Alexander-Universität Erlangen-Nürnberg, Institut für Wirtschaftspolitik und Quantitative Wirtschaftsforschung (IWQW).
  14. Zöttl, Gregor, 2011. "On optimal scarcity prices," International Journal of Industrial Organization, Elsevier, vol. 29(5), pages 589-605, September.

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