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Pricing, Investments and Mergers with Intertemporal Capacity Constraints

We set up a duopoly model with dynamic capacity constraints under demand uncertainty. We endogenize the investment decisions of the ?rms, examine their intertemporal pricing behavior, their incentives to merge, as well as the welfare implications of a merger. Whereas under known and constant demand the high capacity ?rm lets its low capacity rival sell out, under demand uncertainty we obtain a rich set of sales patterns. Each unit of available capacity has an option value (or opportunity cost), which depends on both ?rms? capacities, the current demand and the remaining horizon. This option value may be higher when the ?rms act non-cooperatively compared to the case when they merge to form a monopoly. Trade surplus may be higher when a merger takes place, as capacity is more e? ciently managed over time. The prospect of a merger also leads to higher investment levels, as each ?rm wishes to appropriate a higher share of the total surplus. For some levels of the capacity installment cost, a merger that turns the duopoly into a monopoly is welfare improving.

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Paper provided by Department of Economics, University of Macedonia in its series Discussion Paper Series with number 2009_06.

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Date of creation: Mar 2009
Date of revision: Mar 2009
Handle: RePEc:mcd:mcddps:2009_06
Contact details of provider: Web page: http://www.uom.gr/index.php?tmima=3

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  1. de Frutos, María-Ángeles & Fabra, Natalia, 2011. "Endogenous capacities and price competition: The role of demand uncertainty," International Journal of Industrial Organization, Elsevier, vol. 29(4), pages 399-411, July.
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  3. Farrell, J. & Shapiro, C., 1988. "Horizontal Mergers: An Equilibrium Analysis," Papers 17, Princeton, Woodrow Wilson School - Discussion Paper.
  4. Brock, William A & Scheinkman, Jose A, 1985. "Price Setting Supergames with Capacity Constraints," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 371-82, July.
  5. Beth Allen & Raymond Deneckere & Tom Faith & Dan Kovenock, 1994. "Capacity Precommitment as a Barrier to Entry:A Bertrand-Edgeworth Approach," Industrial Organization 9411002, EconWPA, revised 14 Nov 1994.
  6. 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.
  7. Garcia, Alfredo & Reitzes, James D & Stacchetti, Ennio, 2001. "Strategic Pricing when Electricity is Storable," Journal of Regulatory Economics, Springer, vol. 20(3), pages 223-47, November.
  8. Mireia Jofre-Bonet & Martin Pesendorfer, 2003. "Estimation of a Dynamic Auction Game," Econometrica, Econometric Society, vol. 71(5), pages 1443-1489, 09.
  9. Osborne, Martin J. & Pitchik, Carolyn, 1983. "Price Competition in a Capacity-Constrained Duopoly," Working Papers 83-08, C.V. Starr Center for Applied Economics, New York University.
  10. Levin, Dan, 1990. "Horizontal Mergers: The 50-Percent Benchmark," American Economic Review, American Economic Association, vol. 80(5), pages 1238-45, December.
  11. 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.
  12. Benoit, Jean-Pierre & Krishna, Vijay, 1987. "Dynamic Duopoly: Prices and Quantities," Review of Economic Studies, Wiley Blackwell, vol. 54(1), pages 23-35, January.
  13. Levitan, Richard & Shubik, Martin, 1972. "Price Duopoly and Capacity Constraints," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 13(1), pages 111-22, February.
  14. Baik, Kyung Hwan, 1995. "Horizontal mergers of price-setting firms with sunk capacity costs," The Quarterly Review of Economics and Finance, Elsevier, vol. 35(3), pages 245-256.
  15. Raymond Deneckere & Carl Davidson, 1985. "Incentives to Form Coalitions with Bertrand Competition," RAND Journal of Economics, The RAND Corporation, vol. 16(4), pages 473-486, Winter.
  16. Wedad Elmaghraby & P{\i}nar Keskinocak, 2003. "Dynamic Pricing in the Presence of Inventory Considerations: Research Overview, Current Practices, and Future Directions," Management Science, INFORMS, vol. 49(10), pages 1287-1309, October.
  17. Dudey, Marc, 1992. "Dynamic Edgeworth-Bertrand Competition," The Quarterly Journal of Economics, MIT Press, vol. 107(4), pages 1461-77, November.
  18. Gabriel Bitran & René Caldentey, 2003. "An Overview of Pricing Models for Revenue Management," Manufacturing & Service Operations Management, INFORMS, vol. 5(3), pages 203-229, August.
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