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Lect 7. Strategic Competition

So far S C

With SC C S

SC deals with # firms in market relative to #that could be

Entry conditions

Potential entry (competition) Influence of existing firms on entry

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How is market structure measured

How measure

Define market

Concentration Ratio

HHI

Factors determining concentration

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What determines MS

EOS

Entry Conditions (related to EOS)

Barriers to entry (definition controversial) Capital costs or other costs

Are capital costs different for entrant (E) than

incumbent (I)

May be more difficult for E to get financing

otherwise should be equal

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Barriers to entry cont

Other costs

Brand preferences

Advertising, etc.

FTC and courts have suggested letting

everyone use brand

Reallemon, Kodak, etc.

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Contestable Mkts. and Sunk Costs

Define sunk costsnot recoverable

Perfect contestable

No disadvantage to E

No sunk costs

Entry lag for E

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Theory of SC Behavior

Start with idea that there are few monopoliesin unregulated industries USS, IBM, TexasInstruments

Dominant firm behavior with competitivefringe

Dominant firm price leadership

Graph

Outcomedominance depends on elasticity

>e impact of dominance

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Price Leadership in Practice

Dominant firm Auto GM

Not always dominant firm tobaccorotating

Not always low cost USS

Big problem meaningful and useful relief

Dont follow me

Maybe a useful way to determine prices

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Limit Pricing--dynamic

Set price low enough to deter entry

Completely

Strategically

Some dominant firms lose MS rapidly, some

do notcould this be limit pricing for the

latter

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Limit pricing cont

Dominant firm options

Myopic P that max in each period

Limit price no entry

Optimal limit price some entry may be

permitted over time

What determines opt CD v Cf; r

Examples Campbell soup

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How it works

Bain-Sylos postulate

E assumes output invariance of I

Large firm entrant

Find residual D for E

Graphs

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Does Bain Postulate Work

Probably notbad assumption

Recall it assumes q invariant like Cournot

But in Cournot if E increases q, then Idecreases qi

If entry is deterred, preentry qi must impact

cost of entry

post entry equilibrium

profits

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How?

If output adjustment costs

Adjustment costs for I. These are costs

of changing capacity-new equipment, hire morelabor, etc.

Ca(qt

)=100+20qt

+1/2(qt

-qt-1

)2

Ca ismin when (qt-qt-1)=0 ie no change in q

Ca high, I less likely to change q so may be morelike Cournot

So if Ca>0, equilibrium with entry is Cournotqigreater after entry the higher it was preentry

Therefore incentive for qi to be high.

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Uncertainty by E

E uncertain about D and C after entry I may

try to influence beliefs

E doesnt know MCI

E wont enter if MCI < MCE

E profitable if MCI >= MCE

If qI high, PI low so E expects low MCInoentry

Is high q may be to falsely signal low MCI

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Actual Behavior

To deter entry I must influence:

Profit of E

Post entry D

Es costs

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Important lessons

Capacity is durablelasts for many periods,

affects Is future costs and post entry equil.

Thus a good method to deter entry.

There may be situations where the cost of

capacity is such that it not profitable to

expand capacity to deter entry.

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Raising rivals costs

Large firm agrees to generous labor contract if

union imposes same contract on smaller more

labor intensive firmsAppalachian Coal

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Brand proliferation

Brand Proliferation

Two products, X=cornflakes, Y =cherios; one I and

one potential E

I produces only X

When would I produce X and Y; remember they

are substitutes

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Brand Prolifcont

(XYI,NE)> (XI,YE)+ (YI,XE)

X,Y are substitutes so if I(XY), --monop so

P>than if I(X) and E(Y) and can coordinate qs

of X and Y

If not threat of entry, Y isnt produced

US breakfast cereal industry

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Other forms of preemption

Buying key locations

Controlling key input

New plants Patent introduction (ATT)

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Summary

CS

Price leadership

Limit pricing

Adjustment costs Uncertainty

Cost Reducing capital

Raising costs

Brand Proliferation

Now some cases