SFB 303 Discussion Paper No. A - 264

Author: Bös, Dieter, and Lorenz Nett
Title: Privatization, Price Regulation, and Market Entry - An Asymmetric Multistage Duopoly Model
Abstract: This paper deals with a privatized firm facing potential market entry. The firm has inherited excess capacity from its public past. The players have asymmetric costs. Only the entrant must install new capacity, which incurs positive capacity installation costs. The paper considers the subgame perfect equilibria in a four-stage game with perfect foresight. The incumbent and the entrant first decide on the capacities and subsequently on the prices. In both cases the incumbent moves first. The second main part of the paper deals with price-cap constraint on the incumbent. The paper shows that a binding price constraint does not necessarily lead to an increase in capacity and output (capacity trap). If the price constraint is binding and market entry occurs, the entrant sells at a higher price than the incumbent.
JEL-Classification-Number: 610, 619
Creation-Date: December 1989
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