Demand Growth and Strategically Useful Idle Capacity

Abstract

This paper presents a model of an incumbent firm and a potential entrant. If entry occurs, then competition proceeds through Cournot quantity competition. My model, like those of (e.g.) Dixit and Ware, includes a strategic use for capacity prior to entry. However, it differs in that I consider a two period model, in which second period demand is larger than first period demand. I show that demand growth can result in a use for idle capacity. This result does not require the assumption that firms compete in strategic complements, and therefore works with, e.g., linear demand.

Keywords: Demand Growth, Idle Capacity, Firm, Entrant, Cournot, Strategy

JEL Classification: D21, D24, D43, L10, L41