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Forward induction and the excess capacity puzzle: An experimental investigation

  • Brandts, Jordi
  • Cabrales, Antonio
  • Charness, Gary

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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Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number qt0cd986ps.

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Date of creation: 27 Aug 2003
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Handle: RePEc:cdl:ucsbec:qt0cd986ps
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  1. KOHLBERG, Elon & MERTENS, Jean-François, . "On the strategic stability of equilibria," CORE Discussion Papers RP -716, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  8. Geroski, P. A., 1995. "What do we know about entry?," International Journal of Industrial Organization, Elsevier, vol. 13(4), pages 421-440, December.
  9. Huck, Steffen & Muller, Wieland, 2000. "Perfect versus Imperfect Observability--An Experimental Test of Bagwell's Result," Games and Economic Behavior, Elsevier, vol. 31(2), pages 174-190, May.
  10. Drew Fudenberg & David K. Levine, 1996. "The Theory of Learning in Games," Levine's Working Paper Archive 624, David K. Levine.
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  18. van Damme, Eric, 1989. "Stable equilibria and forward induction," Journal of Economic Theory, Elsevier, vol. 48(2), pages 476-496, August.
  19. Colin Camerer & Teck-Hua Ho, 1999. "Experience-weighted Attraction Learning in Normal Form Games," Econometrica, Econometric Society, vol. 67(4), pages 827-874, July.
  20. Cooper, Russell & Douglas V. DeJong & Robert Forsythe & Thomas W. Ross, 1993. "Forward Induction in the Battle-of-the-Sexes Games," American Economic Review, American Economic Association, vol. 83(5), pages 1303-16, December.
  21. Balkenborg, Dieter, 1994. "An Experiment on Forward- versus Backward Induction," Discussion Paper Serie B 268, University of Bonn, Germany.
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  25. Singh, Satwinder & Utton, Michael & Waterson, Michael, 1998. "Strategic behaviour of incumbent firms in the UK," International Journal of Industrial Organization, Elsevier, vol. 16(2), pages 229-251, March.
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