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Capacity precommitment as a barrier to entry: A Bertrand-Edgeworth approach

  • Dan Kovenock


    (Department of Economics, Krannert School of Management, Purdue University,West Lafayette, IN 47907, USA)

  • Raymond Deneckere

    (Department of Economics, University of Wisconsin, Madison, WI 53706-1393, USA)

  • Tom Faith

    (Faith Consulting, Noorderhavenkade 87 A-1, 3039 RK Rotterdam, THE NETHERLANDS)

  • Beth Allen

    (Department of Economics, University of Minnesota, Minneapolis, MN 55455, USA)

With few exceptions, the literature on the role of capacity as a strategic entry deterrent has assumed Cournot competition in the post-entry game. In contrast, this paper studies a model in which the incumbent and entrant sequentially precommit to capacity levels before competing in price. Interesting deterrence effects arise because firms need time to build, that is, cannot adjust capacity instantaneously in the post-entry game. This approach produces a simple and intuitive set of equilibrium behaviors and generates clear predictions about when these different outcomes are likely to arise. Our model also departs substantially from the existing literature in concluding that sunkness of capacity costs is neither necessary nor sufficient for capacity to have precommitment value.

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Article provided by Springer in its journal Economic Theory.

Volume (Year): 15 (2000)
Issue (Month): 3 ()
Pages: 501-530

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Handle: RePEc:spr:joecth:v:15:y:2000:i:3:p:501-530
Note: Received: August 25, 1999; revised version: October 15, 1999
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  1. Basu, Kaushik & Singh, Nirvikar, 1990. "Entry-Deterrence in Stackelberg Perfect Equilibria," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(1), pages 61-71, February.
  2. A. Michael Spence, 1977. "Entry, Capacity, Investment and Oligopolistic Pricing," Bell Journal of Economics, The RAND Corporation, vol. 8(2), pages 534-544, Autumn.
  3. Shapiro, Carl, 1989. "Theories of oligopoly behavior," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 6, pages 329-414 Elsevier.
  4. Dixit, Avinash, 1979. "The Role of Investment in Entry-Deterrence," The Warwick Economics Research Paper Series (TWERPS) 140, University of Warwick, Department of Economics.
  5. Dixon, Huw, 1985. "Strategic Investment in an Industry with a Competitive Product Market," Journal of Industrial Economics, Wiley Blackwell, vol. 33(4), pages 483-99, June.
  6. Richard E. Levitan & Martin Shubik, 1970. "Price Duopoly and Capacity Constraints," Cowles Foundation Discussion Papers 287, Cowles Foundation for Research in Economics, Yale University.
  7. Allen, Beth, 1993. "Capacity precommitment as an entry barrier for price-setting firms," International Journal of Industrial Organization, Elsevier, vol. 11(1), pages 63-72, March.
  8. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  9. Raymond Deneckere & Dan Kovenock, 1988. "Price Leadership," Discussion Papers 773, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. Bulow, Jeremy & Geanakoplos, John & Klemperer, Paul, 1985. "Holding Idle Capacity to Deter Entry [The Role of Investment in Entry Deterrence]," Economic Journal, Royal Economic Society, vol. 95(377), pages 178-82, March.
  11. Deneckere, R., 1989. "Capacity-Constrained Price Competition When Unit Costs Differ," Purdue University Economics Working Papers 958, Purdue University, Department of Economics.
  12. Raymond Deneckere & Dan Kovenock, 1994. "Capacity-Constrained Price Competition when Unit Costs Differ," Industrial Organization 9411001, EconWPA, revised 15 Nov 1994.
  13. David M. Kreps & Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 326-337, Autumn.
  14. Saloner, Garth, 1985. "Excess capacity as a policing device," Economics Letters, Elsevier, vol. 18(1), pages 83-86.
  15. Joseph E. Stiglitz, 1987. "Technological Change, Sunk Costs, and Competition," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 18(3), pages 883-947.
  16. Allen, Beth & Hellwig, Martin, 1986. "Price-Setting Firms and the Oligopolistic Foundations of Perfect Competition," American Economic Review, American Economic Association, vol. 76(2), pages 387-92, May.
  17. Franco Modigliani, 1958. "New Developments on the Oligopoly Front," Journal of Political Economy, University of Chicago Press, vol. 66, pages 215.
  18. Fudenberg, Drew & Tirole, Jean, 1984. "The Fat-Cat Effect, the Puppy-Dog Ploy, and the Lean and Hungry Look," American Economic Review, American Economic Association, vol. 74(2), pages 361-66, May.
  19. Spulber, Daniel F, 1981. "Capacity, Output, and Sequential Entry," American Economic Review, American Economic Association, vol. 71(3), pages 503-14, June.
  20. Carl Davidson & Raymond Deneckere, 1986. "Long-Run Competition in Capacity, Short-Run Competition in Price, and the Cournot Model," RAND Journal of Economics, The RAND Corporation, vol. 17(3), pages 404-415, Autumn.
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