Issue 4

Volume 1 JOURNAL OF ECONOMICS & MANAGEMENT STRATEGY
December 1992

A Modelof Competitive Limit Pricing

Kyle Bagwell
This paper offers a new theory of limit pricing. Incumbents from different markets or regions “compete” against one another, with each attempting to price in a manner that deflects entry into the others' markets. An entrant is imperfectly informed as to the incumbents' respective investments in cost reduction and seeks to enter markets in which incumbents have high costs. In a focal equilibrium, the entrant uses a simple “comparison strategy,” in which it enters only the highest-priced markets, and incumbents engage in limit-pricing behavior. The influence on pricing of the number of markets and the scope of entry is also reported. Throughout, the central feature of the analysis is that an incumbent's price affects its investment incentives, with lower prices being complementary to greater investment.

Systematic Price Differences Between Successive Auctionsare no Anomaly

Jane Black and David de Meza
Identical cases of wine are often auctioned one immediately after another. Ashenfelter (1989) reports that on average, the later lots fetch less. Such a systematic price difference seems anomalous, the more so because it is shown here that rational expectations imply not equal, but rising, prices. Risk aversion is an obvious way of reconciling the evidence with rational behavior. There is an alternative explanation. The auctions observed by Ashenfelter involved a buyer's option, whereby the first-round winner could purchase further cases at the same price. It is shown that this feature may both account for the observed price trajectory and raise seller revenue.

Price Competition When Consumersare Uncertain About Which Firm Sells Which Quality

Jean J. Gabszewicz and Isabel Grilo
In this paper we analyze the properties of price equilibria in a duopoly market where firms sell vertically differentiated products, consumers being uncertain about which firm sells which quality. Both existence and properties of price equilibria are characterized by the beliefs of the consumers' population about the distribution of quality between firms.

Integration, Complementary Products, and Variety

Jeffrey Church and Neil Gandal
This paper examines the incentives for integration when the market for consumer durables (hardware) is oligopolistic and the market for complementary services (software) is monopolistically competitive. We find that the equilibrium industry structure will depend on the magnitude of the fixed costs of software development. If the software development costs are relatively large, the equilibrium industry structure is unintegrated, that is, neither hardware firm integrates; if the software development costs are relatively small, the equilibrium industry structure is integrated, that is, both hardware firms integrate. Under the integrated industry structure, hardware profits are lower, less varieties are provided, and hardware prices are lower than under the unintegrated industry structure. The game has a prisoners' dilemma structure when the software development costs are relatively small because of a foreclosure effect. Strategically increasing the number of software varieties provides an avenue for an integrated hardware firm to increase its market share and profits by reducing the number of software varieties available for an unintegrated rival technology. Although consumer surplus is higher under an integrated industry structure, the total surplus associated with the unintegrated industry structure exceeds that of the integrated industry structure.

Upstream Pricing and Advertising Signal Downstream Demand

Svend Albák and Per Baltzer Overgaard
This paper considers price and advertising decisions by a monopolist manufacturer who is privately informed about the strength of consumer demand. Consumers respond to advertising and to the retail price chosen by an uninformed retailer on the basis of his beliefs about demand. This signaling game has a unique intuitive equilibrium outcome in which a high-demand manufacturer chooses his full-information pair of wholesale price and advertising. When demand is low, the wholesale price is distorted downward from its full information level, whereas demand-enhancing advertising may be distorted in either direction. Dissipative advertising is not distorted because it is never used.

Innovation, Product Durability, and Market Structure

Gregory E. Goaring
Because many durable goods industries are also industries with significant innovative activity, we analyze the relationship between an oligopolistic firm's choice of product durability and cost-reducing innovation in rental and sales markets. We demonstrate the firm's durability may be greater than, equal to, or less than a social planner's, depending upon innovation's impact on the marginal cost of durability. We also show that the firm's innovation level can be maximized for moderate levels of concentration if the output is durable. This provides theoretical support for the empirical observation that innovation is often maximized in markets of moderate concentration.