Chapter 12

Question 1

Entry accommodation

Answer 1

The entrant is better off by entering since its gross profits are always greater

Question 2

Entry deterrence

Answer 2

The entrant is better of by not entering. No matter what capacity the entrant chooses, its gross profit does not compensate for the entry cost

Question 3

Blockaded entry

Answer 3

The entrant’s gross profit does not compensate for the entry cost

Question 4

The Stackelberg model

Answer 4

Characterizes an incumbent’s optimal strategy if entry is a given. Corresponds to the strategy of entry accommodation.

Inverse demand p = a - bQ

Question 5

Equilibrium profit (Stackelberg model)

Answer 5

Profit2(q1)= (1/4b)(a-c2-bq1)^2

Firm 1 sets a higher output level and earns a higher profit than Firm 2: leadership has its benefits.

Question 6

Entry deterrence in capacity setting games:

Answer 6

Firm 2 prefers not

to enter if: E => (1/4b)*(a - c2 - bq1)^2

Question 7

Entry deterrence in capacity setting games:

Answer 7

Firm 2 prefers not to enter if: E <= (1/4b)*(a - c2 - bq1)^2

Question 8

Incumbent’s optimal capacity choice (Stackelberg model)

Answer 8

An incumbent’s optimal capacity choice depends on the level of entry costs. If entry costs are very high, then the incumbent should set monopoly capacity and ignore the threat of entry.

If entry costs are very low, then the incumbent should choose capacity taking into the entrant’s best response.

Finally, if entry costs are intermediate, then the incumbent should choose capacity large enough to induce the entrant not to enter.

Question 9

Capacity pre-emption

Answer 9

It is crucial that each player’s choice be irreversible. Irreversibility as the foundation of commitment is a general principle of game theory. Irreversibility roughly corresponds to the sunkness of capacity decisions.

Capacity pre-emption is a credible strategy only if capacity costs are high and sunk

Question 10

Product proliferation

Answer 10

Incumbent firms offer a variety of similar products to fill in the product space so as to eliminate any opportunity for profitable entry.

By increasing the density of product offerings, an incumbent firm may deter entry even when profit margins are high.

Question 11

Naked exclusion

Answer 11

By signing up a sufficient number of buyers, the incumbent effectively makes entry unprofitable

Question 12

Divide and conquer strategy

Answer 12

A fraction (1 - alpha) of buyers are offered a contract with a price a little lower than the monopoly price in return for agreeing to exclusivity

Question 13

Bundling and tying as a market foreclosure strategy

Answer 13

By bundling or tying the sales of two products, a dominant firm may leverage its power in one market to increase dominance in the other market

Question 14

Raising rivals’ costs as market foreclosure strategy

Answer 14

Contract exclusivity, selective discounts, and most-favoured-nation clauses may be a way of raising rivals’ costs, and, as such, foreclosing competition

Question 15

Predatory pricing (and when successful)

Answer 15

Pricing below cost with the intent to drive the other firm out of the market.

Aggressive behaviour in the first period may als be an optimal if:
𝜌𝜋𝑀 > 𝐿 + (1 + 𝜌)𝜋D

Successful if

1. Prey is financially constraint
2. signals predator’s “ toughness”
3. Capturing a minimum market share early on is crucial for long-term survival

Question 16

Other explanations of predatory pricing

Answer 16

Low-cost signalling

Reputation for toughness

Growing markets

Question 17

Identifying predatory behaviour

Answer 17

Areeda Turner test: prices should be regarded as predatory only if they fall below marginal cost.

Alternatively, one mat look for post-exit prices

Question 18

Welfare effects - Predatory pricing

Answer 18

Predatory pricing implies that, with some probability, the prey may exit the market, leaving the predator with monopoly or near-monopoly power:

Tradeoff: possible higher prices vs lower short-run prices

Question 19

Legal conditions US predatory pricing

Answer 19

1. Price must be below cost.
2. The intent of driving a rival out of the market, together with a reasonable explanation of recouping short-run losses by means of higher future prices.