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Entrants can enter one by one. Game:
Entrants In 1st market, decide to enter or not If entry, incumbent can decide to fight or accomodate
entry Repeat game for all markets
19 Reputation based models Define „weak incumbent“: cost as high as entrant‘s cost
If game would only played once, it would not fight, as it
would be unprofitable
would fighting means set low price: causes loss to both incumbent and
entrant Selten has shown that same result would happen if
game is repeated many times, as long as it is certain that
incumbent is weak.
Case of two entrants:
Case iincumbent would not fight second entrant, as losses will occur
irrespective of what happened with 1st entrant.
No need to build reputation as „game“ ends afterwards
However, then for 1st entrant no fight would happen either both correctly anticipate that incumbent will not fight in round 2, and
entry would occur incumbent has no incentive to fight.
20 Reputation based models Paradox!
Paradox! Gap to reality: there is no certainty
about incumbent being weak or not.
about Suppose entrants believe that with some
probability the incumbent would not be weak but
firm could be so efficient that it still gains profits if it
sets price below the cost of the entrant
sets Strong that incumbent will obviously always fight is no predation, though. It is just more efficient. BUT weak incumbent may exploit uncertainty of
entrant and make it believe that it is strong.
21 Reputation based models Kreps
Kreps and Wilson (1982) show this
reputation effect in a game-theoretic
At the beginning of the game, it would be
profitable to „pretend“ to be strong (if
incumbent is weak in reality)
incumbent However, as the game proceeds it becomes
relatively more costly to pretend, so that
incumbent accomodates entry towards the
end of the game.
trade-off between sacrifiying current profits for
future (higher) returns
22 Signalling models Basis: Milgrom and Roberts (1982) Entrant observes price set by the incumbent
monopolist If certain that monopolist weak: entry profitable If certain that monopolist strong: entry NOT profitable
If However, entrant can‘t tell… Entrant can only guess until entry, then it would learn
immediately if incumbent is weak or strong
immediately weak incumbent will try to mimic a strong one
weak but strong one would not like to be mistaken for a weak one
23 Signalling models
2 possible equilibria. First: strong
strong incumbent sets lower price than its normal
monopoly price in first period
so low that no weak incumbent would like to set it (due to too
Since there is no scope for pretending to be that
strong, a weak incumbent will just choose its normal
monopoly Entrant will immediately learn and can easily decide
to enter or not
to No negative welfare effects. If ineffcient, monopoly
will break, but otherwise sustain because of higher
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This note was uploaded on 01/22/2014 for the course ECON D0T32A taught by Professor Czarnitzkidirk during the Spring '13 term at Katholieke Universiteit Leuven.
- Spring '13