Forward Induction and Entry Deterrence: An Experiment

41 Pages Posted: 15 Jan 2004

See all articles by Jordi Brandts

Jordi Brandts

Instituto de Analisis Economico (CSIC) Barcelona

Antonio Cabrales

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences

Gary Charness

University of California, Santa Barbara (UCSB) - Department of Economics

Date Written: October 5, 2005

Abstract

The Dixit (1980) hypothesis that incumbents use investment in capacity to deter potential entrants has found little empirical support. Bagwell and Ramey (1996) propose a model where, in the unique game-theoretic prediction based on forward induction or iterated elimination of weakly-dominated strategies, the incumbent does not have the strategic advantage. We conduct an experiment with games inspired by these models. In the Dixit-style game, the incumbent monopolizes the market most of the time even without the investment in capacity. In our Bagwell-and-Ramey-style game, the incumbent also tends to keep the market, in contrast to the predictions of an entrant advantage. Nevertheless, we find strong evidence that forward induction affects the behavior of most participants. The results of our games suggest that players perceive that the first mover has an advantage without having to pre-commit capacity. In our Bagwell-Ramey game, evolution and learning do not drive out this perception. We back these claims with data analysis and a theoretical framework for dynamics.

Keywords: Entry, excess capacity, forward induction, equilibrium selection, first-mover advantage

JEL Classification: C70, C91, D42, L11, L12

Suggested Citation

Brandts, Jordi and Cabrales, Antonio and Charness, Gary, Forward Induction and Entry Deterrence: An Experiment (October 5, 2005). Available at SSRN: https://ssrn.com/abstract=486182 or http://dx.doi.org/10.2139/ssrn.486182

Jordi Brandts

Instituto de Analisis Economico (CSIC) Barcelona ( email )

UAB Campus
E-08193 Bellaterra
Spain

Antonio Cabrales

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(34-93) 542 27 65 (Phone)
(34-93) 542 17 46 (Fax)

Gary Charness (Contact Author)

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States
805-893-2412 (Phone)
805-893-8830 (Fax)

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