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Capacity, Entry, and Forward Induction

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  • Kyle Bagwell
  • Garey Ramey

Abstract

When avoidable fixed costs are introduced into the entry model of Dixit (1980) and Ware (1984), there arises a coordination problem in selecting among postentry Nash equilibria. Elimination of weakly dominated strategies allows the entrant to use a market-capturing strategy, consisting of a large capacity commitment that selects the entrant's preferred postentry equilibrium and drives the incumbent from the market. Deterring the entrant's market-capturing strategy typically requires the incumbent to reduce its initial capacity choice. As avoidable fixed costs rise, the incumbent must restrict its capacity by a greater amount, and the relative advantage of the entrant rises.

Suggested Citation

  • Kyle Bagwell & Garey Ramey, 1996. "Capacity, Entry, and Forward Induction," RAND Journal of Economics, The RAND Corporation, vol. 27(4), pages 660-680, Winter.
  • Handle: RePEc:rje:randje:v:27:y:1996:i:winter:p:660-680
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    Cited by:

    1. van Damme, E.E.C. & Larouche, P. & Müller, W., 2006. "Abuse of a Dominant Position : Cases and Experiments," Discussion Paper 2006-020, Tilburg University, Tilburg Law and Economic Center.
    2. Arthur J. Rolnick & Bruce D. Smith & Warren E. Weber, 1998. "Lessons from a laissez-faire payments system: the Suffolk Banking System, 1825-58," Review, Federal Reserve Bank of St. Louis, issue May, pages 105-116.
    3. Luís M. B. Cabral & Thomas W. Ross, 2008. "Are Sunk Costs a Barrier to Entry?," Journal of Economics & Management Strategy, Wiley Blackwell, pages 97-112.
    4. Van Damme, Eric, 2002. "Strategic equilibrium," Handbook of Game Theory with Economic Applications,in: R.J. Aumann & S. Hart (ed.), Handbook of Game Theory with Economic Applications, edition 1, volume 3, chapter 41, pages 1521-1596 Elsevier.
    5. Evdokimov, Piotr & Rustichini, Aldo, 2016. "Forward induction: Thinking and behavior," Journal of Economic Behavior & Organization, Elsevier, vol. 128(C), pages 195-208.
    6. Kyle Bagwell & Garey Ramey, 1994. "Advertising and Coordination," Review of Economic Studies, Oxford University Press, vol. 61(1), pages 153-171.
    7. Wickelgren, Abraham L., 2006. "The effect of exit on entry deterrence strategies," Games and Economic Behavior, Elsevier, vol. 54(1), pages 226-240, January.
    8. Barbot, Cristina & D'Alfonso, Tiziana, 2014. "Why do contracts between airlines and airports fail?," Research in Transportation Economics, Elsevier, vol. 45(C), pages 34-41.

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