Capacity, Entry and Forward Induction

Abstract

When avoidable fixed costs are introduced into the entry model of Dixit (1980) and Ware (1984), there arises a coordination problem in selecting among post-entry Nash equilibria. Elimination of weakly dominated strategies allows the entrant to use a market-capturing strategy, consisting of a large capacity commitment that selects the entrant's preferred post-entry equilibrium and drives the incumbent from the market. Deterring the entrant's market- capturing strategy typically requires the incumbent to reduce its initial capacity choice. As avoidable fixed costs rise, the incumbent must restrict its capacity by a greater amount, and the relative advantage of the entrant rises.

JEL Classification: L1, D4, C7