1. business and industrial
2. company
3. merger and acquisition

Concentration, Merges and Entry Barriers II
Concentration, Merges and Entry Barriers II
Chapter 8.
March 23, 2015
Concentration, Merges and Entry Barriers II
Entry Barriers
There can be many reasons why entry may not occur:
Cost advantages of the incumbent …rms
economies of scale
product di¤erentiation advantages (reputation)
learning experiences
consumers’loyalty
Concentration, Merges and Entry Barriers II
Entry Barriers
Sunk costs generate entry barriers
Sunk Costs: cannot be reversed (legal fees and taxes, market
surveys, advertising costs, equipment, etc.)
Stiglitz (1987)
There are two …rms A and B (potential entrant)
Producing an identical product with identical marginal costs
Sunk costs e
Concentration, Merges and Entry Barriers II
Entry Barriers
Sunk costs generate entry barriers
Proposition 8.5: For any level of sunk cost satisfying
0 < e < π M , there exist a unique SPE where …rm A is a
monopoly earning π A = π M e and …rm B stays out.
Note that this result applies only to homogeneous products!
What would happen if we consider that the …rms play Cournot
after entry...
Firm could receive an amount of φ > 0 upon exit, where
φ e
Concentration, Merges and Entry Barriers II
Entry Barriers
Entry Deterrence
Blockaded entry: the incumbent is not threatened by entry
Deterred entry: The incumbent modi…es its behavior in order
to deter entry. If prices are lowered, then we say that the
incumbent exercises limit pricing
Accommodate entry: Entry occurs, and the incumbent …rm
modi…es its action to take into account of entry that occurs.
Concentration, Merges and Entry Barriers II
Entry Barriers
Entry Deterrence
Bain-Sylos postulate: the entrant believes that the
incumbent would maintain the same output after entry that it
did before entry.
Can we question the validity of the Bain-Sylos postulate?
Concentration, Merges and Entry Barriers II
Entry Barriers
Capacity commitment under the Bain-Sylos postulate
Spence (1977) explicitly distinguishes between capacity and
quantity produced.
Quantity produced is constrained by the amount of capacity
…rm 1 invests in the 1st period.
if entry does not occur, the capacity is underutilized!
In the event of a threat of entry, the incumbent can expand
its output level (reducing price to the level that makes entry
unpro…table)
Concentration, Merges and Entry Barriers II
Entry Barriers
Capacity commitment under the Bain-Sylos postulate
Leader-Follower game
In period 1: …rm 1 has to choose its capacity-output
investment k1 2 [0, ∞)
In period 2: …rm 2 chooses whether to enter (k2 > 0) or to
stay out (k2 = 0)
Firms are identical, and the entrant has to pay an entry cost
E
0.
Concentration, Merges and Entry Barriers II
Entry Barriers
Second Period
Firm 2 takes k1 = k 1 as given and chooses k2
∂π 2 k 1 , k2
∂k2
= 1
k2 =
k1 = 0
2k2
k1
1
2
Then
π2 =
1
k1
2
(1
k1
1
Which is greater than zero i¤ k 1 < 1
k1
2
)
p
2 E
E
Concentration, Merges and Entry Barriers II
Entry Barriers
First Period
Firm 1 knows
p that small changes in its capacity around
k 1 = 1 2 E may induce …rm 2 to alter its entry decision
Firm 1 compare its pro…t with and without entry:
π s = k1 (1 k1 1 2k1 ) versus π M = k1 (1 k1 )
Concentration, Merges and Entry Barriers II
Entry Barriers
Relaxing the Bain-Sylos postulate
Overaccumulation of capacity will not occur
Two stage game (the following …gure illustrates the
marginal-cost function facing the incumbent in the 2nd stage)
assume that capacity accumulation in the 1st stage is costless
to the incumbent
Firm 2 has a unit cost of c, which is the same of the
incumbent for producing beyond its capacity
Concentration, Merges and Entry Barriers II
Entry Barriers
Relaxing the Bain-Sylos postulate
The best-response functions:
Proposition 8.7: The incumbent cannot deter entry by
investing in a large capacity. More generally, investing in
excess capacity cannot serve as a tool for deterring entry.
Concentration, Merges and Entry Barriers II
Entry Barriers
Judo Economics
(Gelman and Salop, 1983): when a potential entrant limits its
capacity su¢ ciently, it is the incumbent’s best interest to
accommodate entry rather than …ght it.
Two stage game: 1st stage the entrant chooses whether to
enter, its capacity level, k, and its price p e
2nd stage: the incumbent (it has an unlimited capacity)
chooses its price, p I
Production is costless, homogeneous product and demand
p = 100 Q
The demand facing each …rm is
qI =
100
100
pI
if p I < p e
I
k p if p I
pe
and q e =
k if p e < p I
0 if p e
pI
Concentration, Merges and Entry Barriers II
Entry Barriers
Judo Economics
Suppose that the entrant enters and sets a capacity k and a
price p e
then, the incumbent can deter entry p I = p e
(π ID = p e (100 p e )) or accommodate entry p I > p e
(π IA = p I (100 k p I ))
Hence under entry-accomodation, the incumbent choose a
p I > p e to max π IA = p I (100 k p I )
p I >p e
(
100
k
)
(100 k )
(100 k )2
Therefore pAI =
, qAI =
, π IA =
2
2
4
(100 k )2
I = p e (100
e)
Comparing π IA =
π
p
D
4
Concentration, Merges and Entry Barriers II
Entry Barriers
Credible Spatial preemption
Firms produce di¤erentiated, substitutable brands, so entry is
likely to cause a head-to-head competition.
How would the incumbent …rm react to partial entry, when
entry into one market would a¤ect the demand in a market for
a substitute good?
Consider a monopoly …rm (…rm 1) which owns two restaurant,
one Chinese (C) and one Japanese (J)
Chinese Restaurant
Japanese Restaurant
Concentration, Merges and Entry Barriers II
Entry Barriers
Credible Spatial preemption
There are two consumers in town who are slightly
di¤erentiated
UC
UJ
β
β
β
p c if eats chinese food :)
λ p J if eats japanese food :(
λ p C if eats japanese food :(
β p J if eats chinese food :)
Concentration, Merges and Entry Barriers II
Entry Barriers
Entry into the market for Chinese food
A new Chinese restaurant (…rm 2) that serves food identical
to …rm 1
p1C = p2C = 0
How would entry into the Chinese food market a¤ect
the price of a Japanese dinner?
The maximum price the monopoly could charge is p J = λ
Now suppose …rm 1 shuts down its Chinese restaurant and
keeps only the Japanese restaurant. Then p1J = β = p2C
Concentration, Merges and Entry Barriers II
Entry Barriers
Limit pricing as cost signaling
Milgrom and Roberts (1982) argue that limit pricing can serve
as cost signaling device to the potential entrant who may not
know the cost structure of the incumbent.
Two periods t = 1, 2 and demand p = 10 Q
Firm 1 (incumbent) has to choose q11 and …rm 2 choose
whether to enter (or not) in t = 2
Assumption: In t = 2, if entry occurs, then both …rms play
Cournot game. If entry does not occur at t = 2, …rm 1
produces the monopoly output level.(incumbent’s action has
not in‡uence on the market structure at t = 2)
Firm 2’s unit-production cost is c2 = 1 and entry cost F2 = 9
The cost structure of …rm 1 is known only to …rm 1
Firm 2 only knows the probability distribution
c1 =
0 with probability 0.5
4 with probability 0.5
Concentration, Merges and Entry Barriers II
Entry Barriers
Limit pricing as cost signaling
Game:
Solving the game assuming a high-cost incumbent
Hence the entry …rm’s expected pro…t is
E π 2 = 12 7 + 12
1.9 > 0, hence it enters
Therefore, given entry, the best strategy for …rm 1 is to select
the monopoly’s output in t = 1
Concentration, Merges and Entry Barriers II
Entry Barriers
Limit pricing as cost signaling
Assume a low-cost incumbent c1 = 0
If …rm 2 were to know then it would not enter!
But …rm 2 does not know.. hence the incumbent has
incentives to reveal its cost to …rm 2
Proposition 8.11: A low cost incumbent would produce
q11 = 5.83 and entry will not occur in t = 2