Capacity Choice Counters the Coase Conjecture

Abstract

The Coase conjecture is the proposition that a durable goods monopolist, who sells over time and can quickly reduce prices as sales are made, will price at marginal cost. We examine that conjecture in a model where there is a small cost for production capacity, and the seller may augment capacity in every period. In the "gap case," any positive capacity cost ensures that in the limit, as the size of the gap and the time between sales periods shrink, the monopolist obtains profits identical to those that would prevail when she could commit ex ante to a fixed capacity, given some weak conditions on demand. Those profits are at least 29.8% of the static monopoly solution. Thus, the Coase conjecture in not robust to capacity costs, with a zero cost producing much lower profits than any positive cost.