Question 1

What makes a threat credible in entry deterrence?

Accepted Answer

A credible threat is one an established firm can convincingly commit to, influencing a potential entrant's decision-making. In the Walmart example, the initial price war threat lacks credibility because Walmart earns more by not fighting. By investing in excess capacity, Walmart signals genuine readiness to engage in a price war, making the threat believable and deterring market entry.

Question 2

How does strategic signaling prevent market entry?

Accepted Answer

Strategic signaling involves taking visible actions that demonstrate commitment to deterring entry. A shipping company might invest in warehouses and vehicles to signal readiness for aggressive pricing. This investment convinces potential entrants that competing would be unprofitable. While reducing short-term profits, the signal helps retain monopoly status long-term by making entry threats credible.

Question 3

Why would an incumbent firm invest in excess capacity?

Accepted Answer

Excess capacity investment serves as a commitment mechanism, making threats of price wars credible. Without it, competitors recognize the incumbent would lose money fighting, so threats are ignored. The investment signals willingness to absorb losses, convincing potential entrants that entry would be unprofitable and deterring them from competing.

Question 4

What are the payoff outcomes in a two-stage entry deterrence game?

Accepted Answer

In a two-stage game, if the entrant stays out, the incumbent earns monopoly profits while the entrant earns zero. If entry occurs and the incumbent fights, both firms lose money. If the incumbent accommodates entry, both earn positive profits but less than monopoly levels. Strategic signaling shifts outcomes by making entry appear unprofitable.

Question 5

How does backward induction explain entry deterrence decisions?

Accepted Answer

Backward induction analyzes the game from the final stage forward. The incumbent knows that if entry occurs, fighting a price war reduces its profits below accommodation levels. Recognizing this, the entrant would enter. However, by investing in capacity beforehand, the incumbent changes the incumbent's incentives, making fighting credible and deterring entry at the first stage.

Question 6

What is the difference between credible and non-credible threats in competition?

Accepted Answer

A non-credible threat is one the incumbent would not rationally execute because it reduces profits. Walmart's initial price war threat is non-credible because fighting earns only 0.8 million versus 1 million from accommodation. A credible threat requires commitment mechanisms like excess capacity that make execution profitable or unavoidable, convincing competitors the threat is real.

Question 7

How does entry deterrence relate to maintaining market monopoly?

Accepted Answer

Entry deterrence allows incumbents to retain monopoly status by discouraging competitors from entering. Through credible threats and strategic signaling, firms convince potential entrants that competition would be unprofitable. While the incumbent's monopoly profits may decrease due to deterrence investments, retaining monopoly status typically yields higher long-term profits than competing with multiple firms.

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