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Capacity, Entry and Forward Induction

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  • Kyle Bagwell
  • Garey Ramey

Abstract

We introduce avoidable fixed costs into the capacity and entry model of Dixit (1980) to produce a coordination problem among multiple postentry equilibria. Elimination of weakly dominated strategies makes it possible for the entrant to play a knockout strategy, consisting of a large capacity commitment which selects the entrant's preferred postentry equilibrium and drives the incumbent from the market. The incumbent must respond to the knockout threat by using judo tactics, involving a reduction in its capacity commitment. In subgame perfect equilibria which are robust to elimination of weakly dominated strategies, the incumbent must accept a market share smaller than the entrant's if avoidable fixed costs are sufficiently high, or cede the market to the entrant if avoidable fixed costs are higher still.

Suggested Citation

  • Kyle Bagwell & Garey Ramey, 1990. "Capacity, Entry and Forward Induction," Discussion Papers 888, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  • Handle: RePEc:nwu:cmsems:888
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    References listed on IDEAS

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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)," Quarterly Review, Federal Reserve Bank of Minneapolis, pages 11-21.
    3. Arthur J. Rolnick & Bruce D. Smith & Warren E. Weber, 1998. "Lessons from a laissez-faire payments system: the Suffolk Banking System (1825-58)," Quarterly Review, Federal Reserve Bank of Minneapolis, pages 11-21.
    4. 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.
    5. 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.
    6. Evdokimov, Piotr & Rustichini, Aldo, 2016. "Forward induction: Thinking and behavior," Journal of Economic Behavior & Organization, Elsevier, vol. 128(C), pages 195-208.
    7. Kyle Bagwell & Garey Ramey, 1994. "Advertising and Coordination," Review of Economic Studies, Oxford University Press, vol. 61(1), pages 153-171.
    8. Wickelgren, Abraham L., 2006. "The effect of exit on entry deterrence strategies," Games and Economic Behavior, Elsevier, vol. 54(1), pages 226-240, January.
    9. 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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