AIO_price_differentiation_etc

selten in in each market there is one potential

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Unformatted text preview: t. 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 If entry entry Repeat game for all markets 19 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 If would be unprofitable would fighting means set low price: causes loss to both incumbent and fighting entrant entrant Selten has shown that same result would happen if Selten game is repeated many times, as long as it is certain that certain incumbent is weak. incumbent Case of two entrants: Case iincumbent would not fight second entrant, as losses will occur ncumbent irrespective of what happened with 1st entrant. irrespective 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 both entry would occur incumbent has no incentive to fight. 20 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 Suppose probability the incumbent would not be weak but strong strong firm 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. make 21 21 Reputation based models Kreps Kreps and Wilson (1982) show this reputation effect in a game-theoretic framework framework At 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 However, relatively more costly to pretend, so that incumbent accomodates entry towards the end of the game. end trade-off trade-off between sacrifiying current profits for future (higher) returns future 22 22 Signalling models Basis: Milgrom and Roberts (1982) Entrant observes price set by the incumbent Entrant monopolist 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 Entrant 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 23 Signalling models 2 possible equilibria. First: strong strong incumbent sets lower price than its normal monopoly price in first period monopoly so so low that no weak incumbent would like to set it (due to too high losses) high Since Since there is no scope for pretending to be that strong, a weak incumbent will just choose its normal monopoly price monopoly Entrant will immediately learn and can easily decide Entrant to enter or not to No negative welfare effects. If ineffcient, monopoly No will break, but otherwise sustain because of higher efficiency. efficiency....
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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.

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