ch12 - Limit Pricing and Entry Deterrence Chapter 12: Limit...

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Chapter 12: Limit Pricing and Entry Deterrence 1 Limit Pricing and Entry Deterrence
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Chapter 12: Limit Pricing and Entry Deterrence 2 Introduction 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
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Chapter 12: Limit Pricing and Entry Deterrence 3 Evolution of market structure Evolution of markets depends on many factors one is relationship between firm size and growth Gibrat’s Law begin with equal sized firms each grows in each period by a rate drawn from a random distribution this distribution has constant mean and variance over time result is that firm size distribution approaches a log-normal distribution Very mechanistic no strategy for growth Including strategic decision making affects distribution but not conclusion that firm sizes are unequal What about the facts in the market place?
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Chapter 12: Limit Pricing and Entry Deterrence 4 Monopoly power and market entry Several stylized facts about entry entry is common entry is generally small-scale so small-scale entry is relatively easy survival rate is low: >60% exit within 5 years entry is highly correlated with exit not consistent with entry being caused by excess profits “revolving door” reflects repeated attempts to penetrate markets dominated by large firms Not always easy to prove that this reflects predatory conduct But we need to understand predation it if we are to find it
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Chapter 12: Limit Pricing and Entry Deterrence 5 Predatory conduct and limit pricing 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
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Chapter 12: Limit Pricing and Entry Deterrence 6 A limit pricing model AC e MC e $/unit Quantity These are the cost curves for the potential entrant D(P) = Market Demand Assume that the incumbent commits to output Q 1 Q 1 Then the entrant’s residual demand is R1 = D(P) - Q 1 R 1 With the residual demand R
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This note was uploaded on 08/08/2011 for the course EC 170 taught by Professor Menegotto during the Fall '08 term at Tufts.

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ch12 - Limit Pricing and Entry Deterrence Chapter 12: Limit...

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