Stackelberg Competition with Endogenous Entry

Abstract

I characterise endogenous market structures where leaders have a first-mover advantage and entry is endogenous. Leaders are always more aggressive than the followers, independently from strategic substitutability or complementarity. Under quantity competition, leaders produce more than any follower and I determine the conditions for entry-deterrence (high substitutability and non increasing marginal costs). Under price competition, leaders set lower prices than the followers (the opposite than with an exogenous number of firms). In contests, leaders invest more than each follower. In all these cases a leadership improves the allocation of resources compared to the Nash equilibrium with endogenous entry. This article studies endogenous market structures where a firm has a first mover advantage in the sense of Stackelberg (1934) on the other firms and entry in the market is endogenous. The article characterises the equilibrium of these endo genous market structures and provides welfare analysis for some of the applications. These market structures emerge in many sectors which are substantially competitive (a fringe of firms is ready to enter whenever there is a profitable opportunity) but where some incumbent firms have a competitive advantage over the followers (because of technological, historical or legal reasons or just because entry was not possible at an earlier stage) and choose their strategies before them.1 While symmetric models of strategic interactions have been widely studied in the presence of endogenous entry in a Marshallian tradition,2 traditional models with incumbent firms facing a competitive fringe of entrants have been mostly limited to the analysis of markets with homogeneous goods and entry deterrence, for instance in the theories of limit pricing and of contestable markets (Baumol et al, 1982). More recently, Vives (1988) has analysed games with sequential entry of multiple firms but without endogenising the entry process; see also Anderson and Engers (1992, 1994).