Competition, Innovation, and Antitrust. A Theory of Market ... - Intertic

1. Competition, Leadership and Entry 3
to commit to strategies before the other firms. For example, the leader can
choose how much to produce before them. Since the equilibrium price depends
on the production of all the firms, the followers must take in consideration the
production of the leader when they decide their own production: for instance,
they may want to produce less if the leader has decided to produce more.
But the leader is aware of these reactions, and decides its own production
level taking into account the expected behavior of the followers: for example,
the leader may want to produce a lot to induce the followers to reduce their
production. Similarly, a price leader chooses its own price taking into account
the impact of this choice on the prices adopted by the followers. Imagine that
the followers are going to increase their prices when they face a price increase
by the leader: then, the leader may want to choose a high price to start with,
so that all firmswillendupwithhighprices.
The last typology of competition completes our taxonomy of the basic
forms of market interaction combining the analysis of leadership and entry.
In the second half the XX century there have been some attempts to model
both these elements. One is the literature on entry deterrence associated
with Bain (1956), Sylos Labini (1956) and Modigliani (1958), who took into
consideration the effects of entry on the predatory behavior of market leaders
mainly in the case of perfectly substitute goods and constant or decreasing
marginal costs. Another important attempt is associated with the theory
of contestable markets by Baumol et al. (1982), which shows that, in the
absence of sunk costs of entry, the possibility of “hit and run” strategies
by potential entrants is compatible only with an equilibrium price equal to
the average cost. One of the main implications of this result is that “one
firm can be enough” for competition when there is at least one aggressive
potential entrant. This theory and its implications do not apply when goods
are imperfect substitute or firm compete in quantities rather than in prices,
which represents a crucial theoretical gap.
These and other attempts were not developed in a coherent and general
game theoretic framework. The development of such a framework is the focus
of this book, whose theoretical contribution is the characterization of the
Stackelberg equilibrium with endogenous entry and of its applications. This
equilibrium is characterized by rational strategies adopted in different stages.
In a first stage, the leader chooses its strategy under rational expectations on
the strategies that will be adopted by the followers and on the entry decisions
of these followers. In a second stage the followers decide whether to enter in
the market or not according to their expectations on profitability. In the
last stage, the followers simultaneously choose their strategies to maximize
profits, knowing the strategy of the leader and taking as given the strategies
of the other followers.
This introductory chapter presents, in the simplest possible way, some
examples of these four different forms of competition and equilibria. Our
initial focus is on models of competition in quantities. After presenting the