13-Deterrence - Limit Pricing and Entry Deterrence 1...

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Limit Pricing and Entry Deterrence 1
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Some anecdotal evidence Alcoa evidence that consistently expanded capacity in advance of demand Safeway in Edmonton evidence that it aggressively expanded store locations in response to potential entry DuPont in titanium oxide rapidly expanded capacity in response to changes in rivals’ costs market share grew from 34% to 46% 2 Evidence on predatory expansion
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A firm that can restrict output to raise market price has market power Microsoft (95% of operating systems) and Campbell’s (70% of tinned soup market) are giants in their industries Have maintained their dominant position for many years Why can’t existing rivals compete away the position of such firms? Why aren’t new rivals lured by the profits? Answer: firms with monopoly power may eliminate existing rivals prevent entry of new firms These actions are predatory conduct if they are profitable only if rivals, in fact, exit e.g., R&D to reduce costs is not predatory 3 Introduction
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4 Monopoly power and market entry Several stylized facts about entry 1. Entry is common Average entry rate in manuf. (# of new firms over a 5-year period relative to the # of incumbent firms at the start of the period) is between 42-52% (Dunne et al, 1995); UK is 2.5-14% (Geroski, 1995), for retail it is 60% (Jarmin at al, 2004). 2. Entry is generally by small-scale Total market share of entrants is between 14-19% (Dunne et al, 1995); UK: 2 to 6% (Geroski, 1995), for retail it is 25% but has been declining (Jarmin at al, 2004). 3. Survival rate is low Percent that exit within 5 and 10 years: 62% and 80% (Dunne et al, 1995); for retail they are 59% and 82% (Jarmin at al, 2004). 4. Entry is highly correlated with exit Cable and Schwalbach, 1991 – corresponding to an entry of 7.7% accounting for 3.2% of the industry output the exit rate is 7% and it accounts for 3.3.%.
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5 Monopoly power and market entry “Revolving Door” Enter – Fail – Exit. reflects repeated attempts to penetrate markets dominated by large firms Not always easy to prove that this reflects predatory conduct We need to understand predation
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Predatory actions come in two broad forms Limit pricing : prices so low that entry is deterred Predatory pricing : prices so low that existing firms are driven out Outcome of either action is the same—the monopolist retains control of the market Legal action focuses on predatory pricing because this case has an identifiable victim a firm that was in the market but that has left Consider first a model of limit pricing Stackelberg leader chooses output first entrant believes that the leader is committed to this output choice entrant has decreasing costs over some initial level of output 6 Predatory conduct and limit pricing
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7 A limit pricing model AC e MC e $/unit Quantity These are the cost curves for the potential entrant These are the cost curves for the potential entrant D(P) = Market Demand Assume that the incumbent commits to output Q 1
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