Excess Capacity and Limit Pricing: An Empirical Test

Abstract

Entry may be inhibited by expectations that incumbents have lower marginal costs. Incumbents may be able to use limit pricing or excess capacity to further this expectation. We construct an empirical model of oligopoly capacity and pricing decisions and of entrant responses. The results support the hypothesis that both lower prices and greater excess capacity inhibit entry. They further support limit pricing, but provide no evidence that oligopolies deliberately install excess capacity to deter entry. The results suggest, however, that limit pricing firms may exploit the entry-inhibiting effects of unintended excess capacity by raising their limit prices.