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Potential Competition in the Presence of Sunk Entry Costs: An Experiment

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  • Dasgupta, Utteeyo

Abstract

I study the effect of sunk entry-costs on potential competition in a multi-market framework, where potential entrants have different home market profits. Although sunk-entry-costs are supposed to increase entry barriers, my experimental results suggest that firms view entry costs differently depending on their home market profits. I find that subjects are reluctant to enter, and compete in another market if they are already earning monopoly rents. Subjects instead, collude tacitly and earn monopoly rents in home markets, thereby weakening the effect of potential competition. In contrast, subjects who earn small secure returns in their home markets aggressively enter the contestable market whenever there are scopes for earning net profits. The threat of entry and the effects of potential competition are strong in the latter situation, forcing the monopoly incumbents to lower prices to limit-pricing levels.

Suggested Citation

  • Dasgupta, Utteeyo, 2009. "Potential Competition in the Presence of Sunk Entry Costs: An Experiment," MPRA Paper 21945, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:21945
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    References listed on IDEAS

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    1. Weitzman, Martin L, 1983. "Contestable Markets: An Uprising in the Theory of Industry Structure: Comment," American Economic Review, American Economic Association, vol. 73(3), pages 486-487, June.
    2. Schwartz, Marius, 1986. "The Nature and Scope of Contestability Theory," Oxford Economic Papers, Oxford University Press, vol. 38(0), pages 37-57, Suppl. No.
    3. Baumol, William J, 1982. "Contestable Markets: An Uprising in the Theory of Industry Structure," American Economic Review, American Economic Association, vol. 72(1), pages 1-15, March.
    4. Don Coursey & R. Mark Isaac & Margaret Luke & Vernon L. Smith, 1984. "Market Contestability in the Presence of Sunk (Entry) Costs," RAND Journal of Economics, The RAND Corporation, vol. 15(1), pages 69-84, Spring.
    5. Evenden, Rhys D. & Williams, Alan W., 2000. "Contestability: The Debate and Industry Policy," Economic Analysis and Policy, Elsevier, vol. 30(1), pages 75-90, March.
    6. Shepherd, William G, 1984. ""Contestability" vs. Competition," American Economic Review, American Economic Association, vol. 74(4), pages 572-587, September.
    7. Coursey, Don & Isaac, R Mark & Smith, Vernon L, 1984. "Natural Monopoly and Contested Markets: Some Experimental Results," Journal of Law and Economics, University of Chicago Press, vol. 27(1), pages 91-113, April.
    8. Kessides, Ioannis N, 1990. "Market Concentration, Contestability, and Sunk Costs," The Review of Economics and Statistics, MIT Press, vol. 72(4), pages 614-622, November.
    9. Peteraf, Margaret A & Reed, Randal, 1994. "Pricing and Performance in Monopoly Airline Markets," Journal of Law and Economics, University of Chicago Press, vol. 37(1), pages 193-213, April.
    10. Glenn W. Harrison & Michael McKee, 1985. "Monopoly Behavior, Decentralized Regulation, and Contestable Markets: An Experimental Evaluation," RAND Journal of Economics, The RAND Corporation, vol. 16(1), pages 51-69, Spring.
    11. Brock, William A, 1983. "Contestable Markets and the Theory of Industry Structure: A Review Article," Journal of Political Economy, University of Chicago Press, vol. 91(6), pages 1055-1066, December.
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    Cited by:

    1. Dasgupta Utteeyo, 2011. "Are Entry Threats Always Credible?," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 11(1), pages 1-41, December.

    More about this item

    Keywords

    potential competition; contestable markets; sunk cost; limit-pricing; hit-and-run entry; collusion; experiment;

    JEL classification:

    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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