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An experiment on strategic capacity reduction

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  • Mikhael Shor

    (University of Connecticut)

Abstract

A firm may strategically decrease capacity to gain bargaining power over its suppliers. Equilibrium models of competition imply that the incentive to reduce capacity to gain buyer power is small because the buyer captures all available surplus by excluding even a single supplier. However, these models can rest on behaviorally untenable actions prescribed to suppliers in equilibrium. In this paper, we test this theory using a laboratory experiment in which subjects compete to supply a single firm. We find that as capacity decreases, so do suppliers’ price requests, but according to a pattern quite different from equilibrium predictions. We find that a buyer has incentive to exclude at least 30% of available suppliers. This result calls for greater antitrust oversight and offers a behavioral explanation for observed reductions in capacity. JEL Classification: C78, C90, L13 Key words: Strategic capacity reduction, Bargaining power, Ultimatum games, Behavioral economics

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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2012-22.

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Length: 26 pages
Date of creation: Jul 2008
Date of revision:
Handle: RePEc:uct:uconnp:2012-22

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Web page: http://www.econ.uconn.edu/
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  1. Goeree, Jacob K. & Holt, Charles A. & Palfrey, Thomas R., 2004. "Regular quantal response equilibrium," Working Papers 1203, California Institute of Technology, Division of the Humanities and Social Sciences.
  2. Abbink, Klaus & Darziv, Ron & Gilula, Zohar & Goren, Harel & Irlenbusch, Bernd & Keren, Arnon & Rockenbach, Bettina & Sadrieh, Abdolkarim & Selten, Reinhard & Zamir, Shmuel, 2003. "The Fisherman's Problem: Exploring the tension between cooperative and non-cooperative concepts in a simple game," Journal of Economic Psychology, Elsevier, vol. 24(4), pages 425-445, August.
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  7. von Ungern-Sternberg, Thomas, 1988. "Excess Capacity as a Commitment to Promote Entry," Journal of Industrial Economics, Wiley Blackwell, vol. 37(2), pages 113-22, December.
  8. A. Michael Spence, 1977. "Entry, Capacity, Investment and Oligopolistic Pricing," Bell Journal of Economics, The RAND Corporation, vol. 8(2), pages 534-544, Autumn.
  9. Mikhael Shor, 2009. "Procedural Justice in Simple Bargaining Games," Working papers 2012-25, University of Connecticut, Department of Economics.
  10. Deck, Cary A. & Wilson, Bart J., 2008. "Experimental gasoline markets," Journal of Economic Behavior & Organization, Elsevier, vol. 67(1), pages 134-149, July.
  11. Weg, Eythan & Zwick, Rami, 1994. "Toward the settlement of the fairness issues in ultimatum games : A bargaining approach," Journal of Economic Behavior & Organization, Elsevier, vol. 24(1), pages 19-34, June.
  12. Judith R. Gelman & Steven C. Salop, 1983. "Judo Economics: Capacity Limitation and Coupon Competition," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 315-325, Autumn.
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