Contestable Markets Under Uncertainty

In this article we present a model of a market which is ex post contestable. We show that in a market characterized by uncertainty a firm will face a tradeoff between efficiency and flexibility and generally will make some precommitments to take advantage of ex ante technologies. We show that in the face of potential entry the incumbent will increase his precommitments and in so doing will affect the probability of entry. The degree of market contestability is therefore endogenously determined by the choice of precommitments. The extent to which precommitments will be used to affect entry probabilities is shown to depend on the efficiency of ex ante production, adjustment costs, and the degree of uncertainty. In particular, we show that the market becomes "more contestable" as the relative efficiency of ex post production increases and as market conditions become more uncertain.

[1]  Daniel F. Spulber.  Capacity, Output, and Sequential Entry , 1981 .

[2]  E. Appelbaum,et al.  Estimating Technology in an Intertemporal Framework: A Neo-Austrian Approach , 1977 .

[3]  Richard C. Hartman.  Factor Demand with Output Price Uncertainty , 1976 .

[4]  Larry G. Epstein.  Production Flexibility and the Behaviour of the Competitive Firm under Price Uncertainty , 1978 .

[5]  Paul R. Milgrom,et al.  LIMIT PRICING AND ENTRY UNDER INCOMPLETE INFORMATION: AN EQUILIBRIUM ANALYSIS' , 1982 .

[6]  M. Spence,et al.  Contestable Markets and the Theory of Industry Structure: A Review Article , 1983 .

[7]  Leonard J. Mirman,et al.  Equilibrium Limit Pricing: The Effects of Private Information and Stochastic Demand , 1983 .

[8]  Avinash Dixit,et al.  A MODEL OF DUOPOLY SUGGESTING A THEORY OF ENTRY BARRIERS , 1978 .

[9]  D. Osborne.  On the Rationality of Limit Pricing , 1973 .

[10]  T. Schelling,et al.  The Strategy of Conflict. , 1961 .

[11]  W. Baumol,et al.  Contestable Markets and the Theory of Industry Structure , 1982 .

[12]  H. Levy,et al.  Efficiency analysis of choices involving risk , 1969 .

[13]  E. Bailey,et al.  Market Structure and Multiproduct Industries , 1982 .

[14]  J. Bain.  Barriers to new competition , 1957 .

[15]  S. Salop.  Strategic Entry Deterrence , 1979 .

[16]  Josef Hadar,et al.  Rules for Ordering Uncertain Prospects , 1969 .

[17]  S. Turnovsky.  Production Flexibility, Price Uncertainty and the Behavior of the Competitive Firm , 1973 .

[18]  A. Spence.  Entry, Capacity, Investment and Oligopolistic Pricing , 1977 .