Actions a firm takes in one market may affect its profitability in other markets, beyond any joint economies or diseconomies in production. The reason is that an action in one market, by changing marginal costs in a second market, may change competitors' strategies in that second market. We show how to calculate the strategic consequences in market 2, of a change in conditions in market 1 or of a firm's action in market 1. Qualitatively, the same results hold for both simultaneous markets and sequential markets: whether a more aggressive (i.e., lower price or higher quantity) strategy in the first market provides strategic costs or benefits depends on (a) whether competitors' products are strategic substitutes or strategic complements. The latter distinction is determined by whether more aggressive play by one firm in a market raises or lowers competing firms' marginal profitabilities in that market. We discuss applications to how firms select "portfolios" of businesses in which to compete, to rational retaliation as a barrier to entry, to international trade, and to the learning curve. Both strategic substitutes competition and strategic complements competition are compatible with either quantity competition or price competition. For example, strategic complements competition arises from price competition with linear demand and from quantity competition with constant elasticity demand. The distinction between strategic substitutes and strategic complements is also important in other areas of industrial organization. For example, we show that with strategic complements competition firms will strategically underinvest in fixed costs. This contrasts with earlier studies which, focusing on the total profits of potential entrants rather than the marginal profits of established competitors, invariably emphasized the use of excess capacity.
|Date of creation:||Aug 1983|
|Publication status:||Published in Journal of Political Economy (1980), 93(3): 488-511|
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|Order Information:|| Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA|
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- Milgrom, Paul & Roberts, John, 1982.
"Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis,"
Econometric Society, vol. 50(2), pages 443-459, March.
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- Jeremy I. Bulow & John Geanakoplos, 1983. "Strategic Resource Extraction: When Easy Doesn't Do It," Cowles Foundation Discussion Papers 675, Cowles Foundation for Research in Economics, Yale University.
- Schmalensee, Richard, 1983. "Advertising and Entry Deterrence: An Exploratory Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 636-653, August. Full references (including those not matched with items on IDEAS)
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