Staff Report 187

Capacity Precommitment as a Barrier to Entry: A Bertrand-Edgeworth Approach

Beth Allen
Dan Kovenock
Raymond Deneckere
Tom Faith

Published February 1, 1995

This paper considers the role of capacity as a strategic entry deterrent for a game in which the incumbent and entrant sequentially precommit to capacity levels before competing in price, possibly using mixed strategies. Depending on the magnitudes of the fixed set-up cost, the cost of capacity, and the relative costs of production, the model produces a wide spectrum of equilibrium behaviors, including some not previously suggested in the literature. Interesting deterrence effects occur because firms need time to build. In contrast to much previous work, the incumbent may hold idle capacity when entry is deterred.

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