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Reputation and Imperfectly Observable Commitment: The Chain Store Paradox Revisited

Brigitte Adolph
Humboldt University of Berlin - Faculty of Economics

Elmar Wolfstetter
Humboldt University of Berlin - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); World Bank; Korea University - College of Economics and Commerce

October 1996

Abstract:
In their seminal solution of the chain store paradox Kreps and Wilson assumed that the incumbent monopolist is predisposed, with a small probability, to ght entry. Milgrom and Roberts suggested to view this predisposition to ght as a result of precommitment to an aggressive course of action. However, they did not examine whether such an ability to make commitments is actually chosen by a rational incumbent monopolist. The present paper fills this gap. We assume that the monopolist has access to an appropriate commitment mechanism, with a small probability. Due to the possibility of misunderstanding or communication error, commitments are not perfectly observable. Otherwise, the assumptions of Kreps and Wilson are maintained. These plausible modifications have drastic implications: Precommitment becomes useless, and reputation effects break down; Selten's chain store paradox comes back in full force.

JEL Classifications: D43, D82, D72

Working Paper Series

Date posted: February 06, 1997 ; Last revised: March 13, 1998

Suggested Citation

Adolph, Brigitte and Wolfstetter, Elmar G., Reputation and Imperfectly Observable Commitment: The Chain Store Paradox Revisited (October 1996). Available at SSRN: http://ssrn.com/abstract=2171 or doi:10.2139/ssrn.2171

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Contact Information

Brigitte Adolph (Contact Author) Humboldt University of Berlin - Faculty of Economics ( email ) Spandauer Strasse 1 Berlin Germany +49 30 2093 5652 (Phone) +49 30 2093 5619 (Fax)
Elmar G. Wolfstetter Humboldt University of Berlin - Faculty of Economics ( email ) Institut für Wirtschaftstheorie I Spandauer Strasse 1 Berlin Germany +49 30 2093 5652/3 (Phone) +49 30 2093 5619 (Fax) HOME PAGE: http://www.wiwi.hu-berlin.de/wt1/
CESifo (Center for Economic Studies and Ifo Institute for Economic Research) Poschinger Str. 5 DE-81679 Munich Germany HOME PAGE: http://www.CESifo.de
World Bank ( email ) 1818 H Street NW Washington, DC 20433 United States 202-458-5426 (Phone)
Korea University - College of Economics and Commerce ( email ) Anam-dong, Sungbuk-Ku Seoul 136-701 Korea