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Forward induction and the excess capacity puzzle: An experimental investigation

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  • Jordi Brandts
  • Antonio Cabrales
  • Gary Charness

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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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 703.

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Date of creation: Jul 2003
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Handle: RePEc:upf:upfgen:703

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Web page: http://www.econ.upf.edu/

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Keywords: Entry; excess; capacity; forward induction; equilibrium selection; first-mover advantage; Leex;

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Cited by:
  1. Antonio Cabrales & Antoni Calvó-Armengol, 2003. "Corporate Downsizing to Rebuild Team Spirit," Working Papers 183, Barcelona Graduate School of Economics.
  2. Charness, Gary & Grosskopf, Brit, 2004. "What makes cheap talk effective? Experimental evidence," Economics Letters, Elsevier, vol. 83(3), pages 383-389, June.

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