In a two period strategic model of entry deterrence (a la Dixit, 1980) where the incumbent firm moves before the entrant by installing capacity for production, in a (perfect) equilibrium excess capacity is not observed under a deterministic demand. The question is: Does this result remain valid under demand uncertainty as well? The answer is yes only if the incumbent can produce output beyond the pre-planned capacity, when needed, without incurring any additional cost by expanding its capacity simultaneously while producing output; and no otherwise. Thus a cost reducing investment behavior will lead to excess capacity for an incumbent firm, when there is a potential entrant in the market under demand uncertainty. The other relevant issue that is also analyzed in this paper is to see the impact of the distribution of demand uncertainty on the incumbent's decision, when it faces the choice to deter or accommodate the potential entrant.
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Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number
97-05.
Length: 16 pages Date of creation: May 1997 Date of revision: Handle: RePEc:kud:kuiedp:9705
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Find related papers by JEL classification: D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
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