Question
Question: Stackelberg and Limit Pricing Consider the Limit pricing and Stackelberg models in which the incumbent chooses capacity first and then the entrant chooses whether
Question: Stackelberg and Limit Pricing
Consider the Limit pricing and Stackelberg models in which the incumbent chooses
capacity first and then the entrant chooses whether or not to enter. If the entrant enters
they choose output in Cournot fashion taking the incumbent's capacity choice as given. It
is assumed that 90% of the incumbent's marginal cost is sunk (s = .9) once they make the
capacity choice. Inverted demand is given by P = a - Q, where 'a' is the market size
parameter. Marginal cost is c = 300 and fixed costs are F = 400 for both entrant and
incumbent.
a) Limit pricing. (i) Solve for the incumbent's entry deterring level of output,
limit price and profits as a function of 'a'. (ii) Find the levels of 'a' for which entry is
blockaded. (iii) Find the levels of 'a' for which limit pricing is 'credible'.
b) Stackelberg. (i) Solve for the incumbent's Stackelberg level of output and
profits as a function of 'a'. (ii) Find the values of 'a' for which Stackelberg is credible.
c) Profit comparison and credibility. (i) Are there values of 'a' for which entry
is not blockaded and both limit pricing and Stackelberg are credible. (ii) If so then
determine whether limit pricing or Stackelberg is more profitable for these values of 'a'.
(iii) Based on your analysis what is your prediction about the impact of market size on the
likelihood that entry deterring behavior will be observed in the data?
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