Capacity, Entry and Forward Induction
AbstractWe introduce avoidable fixed costs into the capacity and entry model of Dixit (1980) to produce a coordination problem among multiple postentry equilibria. Elimination of weakly dominated strategies makes it possible for the entrant to play a knockout strategy, consisting of a large capacity commitment which selects the entrant's preferred postentry equilibrium and drives the incumbent from the market. The incumbent must respond to the knockout threat by using judo tactics, involving a reduction in its capacity commitment. In subgame perfect equilibria which are robust to elimination of weakly dominated strategies, the incumbent must accept a market share smaller than the entrant's if avoidable fixed costs are sufficiently high, or cede the market to the entrant if avoidable fixed costs are higher still.
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Bibliographic InfoPaper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 888.
Date of creation: May 1990
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