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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