Limit Pricing and Entry Dynamics with Heterogeneous Firms

Abstract

In this paper we study a dynamic model of pricing and investment with heterogeneous firms under imperfect competition. We assume the existence of two types of firms, a dominant firm and fringe firms. We introduce several asymmetries between the two types of firms. The dominant firm is not financially constrained. It has free access to capital markets although it is subject to increasing adjustment cost of investment. On the other hand, the fringe firms are credit constrained and have no access to capital markets so that they are restricted to internal finance of investment. Furthermore, it is assumed that the dominant firm acts as a price setter and it controls both prices and investment while the fringe firms are price takers who can control only their own investment through internal retention. The formal structure of our model is described by a dynamic game. More particularly, it represents an open loop Stackelberg differential game of two firms in which the dominant firm acts as a leader and fringe firms act passively as followers. We investigate both the steady state as well as the dynamic behavior of the model analytically and numerically.