Entry, Capacity, Investment and Oligopolistic Pricing

TLDR

Capacity may remain underutilized when entry is deterred, even though it is not fully used in the absence of new entrants. The paper argues that entry is deterred when existing firms possess sufficient capacity to render new entrants unprofitable. Capacity and other irreversible investment commitments serve as effective entry‑deterring variables by preemptively committing resources to the industry. The analysis shows that such capacity‑based deterrence leads to higher than necessary costs, elevated prices, and lower output relative to limit‑price model predictions.

Abstract

The paper argues that entry is deterred in an industry when existing firms have enough capacity to make a new entrant unprofitable. This capacity need not be fully utilized in the absence of entry. This can result in larger costs than are necessary, given output levels. It also results in higher prices and lower levels of output than those implied by various forms of the limit price model. Capacity and other forms of investment are effective entry deterring variables, partly because they are irreversible and represent preemptive commitments to the industry.