Capacity, Entry, and Forward Induction

Kyle Bagwell and Garey Ramey

RAND Journal of Economics, 1996, vol. 27, issue 4, 660-680

Abstract: When avoidable fixed costs are introduced into the entry model of Dixit (1980) and Ware (1984), there arises a coordination problem in selecting among postentry Nash equilibria. Elimination of weakly dominated strategies allows the entrant to use a market-capturing strategy, consisting of a large capacity commitment that selects the entrant's preferred postentry equilibrium and drives the incumbent from the market. Deterring the entrant's market-capturing strategy typically requires the incumbent to reduce its initial capacity choice. As avoidable fixed costs rise, the incumbent must restrict its capacity by a greater amount, and the relative advantage of the entrant rises.

Date: 1996
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Working Paper: Capacity, Entry and Forward Induction (1990)
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