Endogenous Market Structures

In this section we present the most recent articles and unpublished papers on the theory of endogenous market structures (characterized by both strategic interactions between firms and endogenous entry of firms). We focus first on the growing literature on general equilibrium models with imperfect competition where the number of firms is endogenized, then on partial equilibrium models of industrial organization where endogenous market structures are taken into account.

MICROECONOMICS AND ENDOGENOUS ENTRY:

Advertising and Search Engines by F. Etro (2013, Research in Economics).

We analyze the role of leadership in a multisided market as search advertising, assuming quantity competition and different entry conditions (with barriers to entry or endogenous entry). The model can be microfounded taking into account network effects, multi-homing on the advertising side and scale in search. If there are barriers to entry and the network effects are strong, there is an incentive for the leader to exploit them and attract more consumers to monopolize advertising. Under barriers to entry, the leading platform has also a strategic incentive to exploit scale in search, to manipulate search results to divert search traffic from other platforms, and to introduce limits to multi-homing, with the aim of expanding its market share and deny scale to competitors.

Top-dog and the Lean and Hungry Look in Endogenous Entry by S. Cato and R. Oki (2011).

This short paper is one of the most interesting recent theoretical works on the theory of leadership in the presence of endogenous market structures. It examines the strategic commitment behavior of multiple heterogeneous leaders when entry of followers in a market is endogenous. The general analysis of the authors demonstrates that each leader’s optimal investment level is independent of the other leaders’ characters. Moreover, it shows that a leader over- (resp. under-) invests when an investment increases (resp. decreases) the leader’s marginal profitability. Such investment always leads the leaders to adopt aggressive strategies relative to the strategies adopeted in the case of no-commitment. This brilliant work clarifies that aggressiveness of the leaders is a robust feature of endogenous market structures.

Endogenous Entry in Markets with Adverse Selection by A. Creane and T. Jeitschko (2010)

This is a pathbreaking paper on the role of endogenous market structures in understanding informational asymmetries. Since Akerlof's (1970) seminal paper the existence of adverse selection due to asymmetric information about quality is well-understood. Yet two questions remain. First, given the negative implications for trading and welfare, how do such markets come into existence? And second, why have many studies failed to find direct or indirect evidence of adverse selection?

In addressing the first question the authors directly shed some light on the second. They consider a market in which firms make an observable investment that generates products of a quality that becomes known only to the firm. Entry has the tendency to lower prices, which may lead to adverse selection. The implied price collapse limits the amount of entry so that high prices are supported in the market equilibrium, which results in above normal profits.

While contributing to our understanding of markets with asymmetric information and adverse selection, the model also provides insight into the question of why markets with adverse selection are empirically hard to identify. The analysis suggests that rather than observing the canonical market collapse, such markets are instead characterized by less entry than would be empirically predicted and above normal profits even in markets with low measures of concentration.

Aggregative Games with Entry by S. Anderson, N. Erkal and D. Piccinin (2010).

This paper provides the most general and complete characterization of equilibria with endogenous market structures where firms undertake alternative strategies. It generalizes a number of results in the literature and discusses many applications.

Consider a mixed oligopoly industry of a public firm and private firms producing differentiated products and demand characterized by the CES model and a free entry zero profit condition. The public firm is then privatized, and there is entry or exit so that private firms again make zero profit. At the new equilibrium, total surplus is higher if and only if the privatized firm was making a loss before the change. Or consider an industry with logit demands and suppose there is a merger, with a zero profit condition for marginal firms both before and after. Even though the merged firm’s price rises and there is new entry, consumer surplus is unaltered. Or consider an R&D race with free entry. Some firms participate in the race as members of a cooperative R&D arrangement. R&D cooperation has no impact on the aggregate rate of innovation in the industry (hence need not be encouraged or discouraged) even though the number of participants in the race increases with R&D cooperation. Or indeed compare a homogenous Cournot industry with free entry with one where a firm acts as Stackelberg leader. The size of fringe firms is the same in these industrial structures, although there are fewer of them. Moving outside IO, consider a rent-seeking (lobbying) game (Tullock) where efforts determine success probabilities via a contest success function. Equilibrium efforts of unaffected firms are independent of efficiency gains (to lobbying) to infra-marginal firms.

What ties together all these examples is that they are all aggregative games, and consumer surplus is a monotonic function of the aggregator. Many noncooperative games studied in the literature are aggregative games, where each player’s payoff depends on his/her own actions and an aggregate of all player’s actions. The goal of this paper is to consider the impact of entry in such games. We consider scenarios where an exogenous change affects some of the players in the market. We detail the comparative statics and welfare properties of efficiency or behavioral changes to infra-marginal agents. Examples of the exogenous changes include (i) cost shocks (subsidies, tariffs), (ii) privatization, and (iii) merger or formation of a RJV. We develop a unifying framework to analyze the impact of the change on the aggregate variable, producer surplus and consumer surplus when the change is followed by entry or exit. The analysis makes extensive use of the cumulative best reply function introduced by Selten (1970), for which we derive the corresponding maximal profit function. Acemoglu and Jensen (2009) have analyzed the short-run comparative statics properties of aggregative games. The contribution of this paper is to consider entry, and impact on consumer welfare and total surplus. A further difference from Acemoglu and Jensen (2009) is that they only consider comparative static changes which affect all of the firms in the industry (so they fall in type (i) above) whereas this paper considers a broader set of changes, but the changes affect only a subset of the firms.

Leadership in Multi-sided Markets and the Dominance in Online Advertising by F. Etro (2011).

This article analyzes the role of leadership in multi-sided markets. Search and display advertising are better characterized by (respectively) quantity and price competition with leadership by a dominant firm and few followers. A platform that reached dominance in search may have an incentive to limit services to consumers to be aggressive with the advertisers, or may be more likely to exploit its scale in search to build barriers to entry and to adopt click-weighted auctions to manipulate the pricing of sponsored links. A dominant platform in display advertising may increase the rewards of content providers to increase prices on advertisers, or may adopt exclusive clauses to predate on other platforms. This creates the potential for multiple antitrust issues.

Quantity-setting Games with a Dominant Firm by A. Tasnadi (2010, Journal of Economics).

This paper considers a possible game-theoretic foundation of Forchheimer’s model of dominant-firm price leadership based on quantity-setting games with one large firm and many small firms. If the large firm is the exogenously given first mover, the author obtains Forchheimer’s model. He also investigates whether the large firm can emerge as a first mover of a timing game.

Welfare-Reducing Mergers in Differentiated Oligopolies with Free Entry by N. Erkal and D. Piccinin (2010, Economic Record) and How Many Firms Should Be Leaders? Beneficial Concentration Revisited by H. Ino and T. Matsumura (2008).

These two interesting articles study mergers in the presence of endogenous entry of firms under different perspectives. The first one shows that antitrust authorities regard the possibility of post-merger entry and merger-generated efficiencies as two factors that may counteract the negative effects of horizontal mergers. This paper shows that in differentiated oligopolies with linear demand, all entry-inducing mergers harm consumer welfare. This is because if there is entry following a merger, it implies that the merger-generated efficiencies were not sufficiently large. Mergers which induce exit, due to sufficiently high cost savings, always improve consumer welfare. The second paper investigates the relationship between the Herfindahl-Hirschman Index (HHI) and welfare. First, it discusses the model where m leaders and N − m followers compete. Daughety (1990) finds that under linear demand and constant marginal costs, the Stackelberg model yields larger welfare and HHI than the Cournot model. Thus, he demonstrates that beneficial concentration occurs. Here it is found that it always occurs when m is sufficiently large under general cost and demand functions but does not always occur when m is small. Next, considering endogenous entry of followers, the authors find that beneficial concentration always occurs regardless of the number of merging firms.

Endogenous Market Structures and Antitrust Policy by F. Etro (2010, International Review of Economics).

This article derives antitrust implications for markets where entry can be regarded as endogenous (contrary to most analysis within the post-Chicago tradition). Many applications concern issues of abuse of dominance. Endogenous entry requires a wide revision of our understanding of the role of incumbents in pricing, producing in the presence of network externalities and multi-sided markets, bundling products, price discriminating and delegating to retailers through vertical restraints: when entry is endogenous, leaders adopt aggressive strategies without exclusionary purposes and without affecting welfare negatively. Endogenous entry has also implications for the analysis of mergers (that take place only if create enough cost efficiencies and do not harm consumers), the evaluation of collusive cartels (that are unfeasible in markets where entry is endogenous) and state aids for exporting firms (which are always unilaterally optimal for international markets with free entry). The spirit of the policy recommendations of the Chicago school is broadly supported by our analysis in a solid game-theoretic framework.

Passive Aggressive Chains by N. Yang (2009).

In this paper, each local retail market consist of establishments run by local entities, and those run by a large national chain. Largely motivated by the observation that industries for which chains typically use uniform pricing are also industries for which a large proportion of establishments are chain-run, the author argues that a chain’s commitment to charge a uniform price across all heterogeneous markets induces it to crowd out the locally run stores when uniform pricing effectively softens price competition. The aggressive behavior is driven by the chain’s desire to protect its profits from entry under the accommodative pricing regime. Of some consolation to consumers, the scope of this policy is reduced as it becomes more detrimental to consumers. In some sense, potential entry of local competitors can align the interests of the chain and consumers.

Successive Oligopolies with Differentiated Firms and Endogenous Entry by M. Reisinger and M. Schnitzer (2009).

This interesting paper develops a model of successive oligopolies with endogenous market structures, allowing for varying degrees of product differentiation and entry costs in both markets. Our analysis shows that the downstream conditions dominate the overall profitability of the two-tier structure while the upstream conditions mainly affect the distribution of profits. The authors compare the welfare effects of upstream versus downstream deregulation policies and show that the downstream deregulation is more effective if the industry is relatively concentrated and vice versa. Furthermore, they analyze how different forms of vertical restraints shape the endogenous market structure and provide conditions under which they are welfare reducing.

How Many Firms Should Be Leaders? Beneficial Concentration Revisited by H. Ino and T. Matsumura (2009).

This interesting work investigates the relationship between the Herfindahl-Hirschman Index (HHI) and welfare. Daughety (1990) finds that in the model wherein m leaders and N-m followers compete under linear cost and demand, the Stackelberg model yields larger welfare and HHI than the Cournot model (beneficial concentration). We find that this always occurs under general cost and demand when m is sufficiently large, but does not always occur when m is small. However, if we consider the free entry of followers, beneficial concentration always occurs regardless of m. In particular, the more persistent the leadership, the more likely it is to be beneficial.

Technological Leadership and the Persistence of Monopoly under Endogenous Entry: Static versus Dynamic Analysis by E. Kovac et al. (2010, Journal of Economic Dynamics & Control).

This important paper builds a dynamic oligopoly model in which a particular firm (leader) invests in process innovations facing subsequent endogenous (or free) entry by other firms (followers). All firms that enter the market incur positive entry costs. The authors identify conditions under which it is optimal for the leader in an initially oligopoly setup with endogenous entry to undertake pre-emptive R&D investment (strategic predation) that eventually leads to the exit of all followers. The novel feature of this approach is that it introduces an explicit dynamic model and compare it with its static counterpart. The dynamic model provides new insights about leader's intertemporal investment choices and about the dynamics of the market structure. The authors also contrast the leader's investment decisions with the decisions of a social planner.

Endogenous Market Structures and Strategic Contracts by F. Etro (2009).

Consider a market with price competition where entry is free and occurs until profits are zero. Is there any contractual commitment that a firm can exploit to gain a competitive advantage and preserve positive profits? Contrary to what one may expect in a market where entry dissipates any profitable opportunities for the entrants, the answer is yes. More important, the kinds of contractual arrangements leading to these gains can be radically different from those emerging in traditional models.

It is well known that in a price duopoly a profit-maximizing firm can increase profitability through a particular form of strategic delegation: this requires a commitment to adopt accommodating strategies which relax competition and increase price and profits of both firms. Vickers (1985), Sklivas (1987) and Fershtman and Judd (1987) have emphasized the gains from delegating pricing decisions to managers with negative sale incentives. Raith (2003) has suggested that, in the presence of moral hazard of the managers, there are gains from incentive schemes (à la Holmstrom and Milgrom, 1991) with a low variable (output-related) compensation that generates low effort and softens competition. Bonanno and Vickers (1988) and Rey and Stiglitz (1995) have emphasized the gains from vertical separation where the upstream firm charges the downstream firm with a francise fee and a wholesale price above marginal cost to increase final prices. In the same spirit, Whinston (1990) has shown that, when a monopolist in a primary market is also active in a secondary duopolistic market, tying is never profitable (except for deterring entry) because its strengthens price competition. Finally, building on Brander and Lewis (1986), Showalter (1995) has emphasized that debt contracts are counterproductive in the presence of cost uncertainty because they lead equity holders to support risky low-price strategies. These results are a consequence of strategic complementarity between price choices (Fudenberg and Tirole, 1984; Bulow et al., 1985): the above forms of strategic contracts induce the managers of the firm to increase the price, so as to induce also the rival firm to increase its price and to generate higher profits for both. Unfortunately, all these results are not robust to changes in the form of competition, and they break down when the two firms compete in quantities rather than in prices: this leaves the literature on strategic contracts with ambiguous results and, when needed, also with uncertain normative implications (for instance in the field of antitrust policy).

As suggested by Etro (2006), a limit of the literature on strategic commitments is that the number of competitors (two in most applications) is pre-determined and independent from the market outcome: this is in stark contrast with most real markets, where entry is attracted by the profitable opportunities left over by the active firms and by expectations on future profitability. This note shows that when a firm is active in a market whose structure is endogenous, that is where the number of competitors (two as above, or more) is endogenously determined by profit conditions, the above contractual commitments can still play a role but in a radically different way. Our results for markets with price competition with endogenous entry can be summarized as follows:
- operative strategies should be always delegated to managers whose objective function is a weighted average of profits and sales, and we characterize the optimal positive sale incentives;
- managerial compensation should provide high-powered incentives with a larger variable compensation than the other firms, and we derive the optimal strategic incentive contract;
- vertical separation between an upstream producer and a downstream retailer should always entail wholesale prices below marginal costs for the downstream firm, and we determine the optimal franchising contract;
- tying is always an effective device to gain profits in a secondary market without fully deterring entry when demand for the bundled good is close enough to the demand of the primary product;
- debt contracts should be always adopted under relevant cost uncertainty, in which case we characterize the optimal financial structure.

The nature of these optimal strategic contracts matches what one would obtain if the same firm was engaged in quantity competition rather than price competition, dissolving the traditional ambiguity associated with the optimal strategic contracts. The reason is that when the market structure is endogenous it is never optimal to commit to a soft behavior, which attracts entry and dissipates all profits; it is better to commit to a tough strategy which expands production and reduces prices (limiting entry and) preserving positive profits. This note characterizes the role of strategic contracts in a number of classic contexts, derive the optimal (unilateral) contracts and verify under which conditions these contracts allow a firm to replicate the best pre-commitment equilibrium (reachable by pre-committing on the price strategy). Our framework can be easily adapted to study any other strategic commitment affecting a firm active in a competitive market.

Endogenous Market Structures and Antitrust Policy by F. Etro (2009).

The recent literature on the endogeneity of market structures has revisited a number of descriptive results of industrial organization for markets with strategic interactions and endogenous entry of firms, and a number of normative results on industrial policy, trade policy and macroeconomic policy.

This article will apply this theoretical apparatus to discuss antitrust policy issues. In particular, it will advance a critical view of the post-Chicago approach to antitrust policy, emphasizing that this approach has often disregarded the consequences of the endogeneity of the market structure. This takes into account both strategic interactions and the endogeneity of the number of strategic players in the market: the hypothesis of endogenous entry should not be interpeted as pure free entry in perfectly competitive markets, but as a condition determining endogenously the size of the market power of the active firms. Taking this into account, standard results of the post-Chicago literature can be radically modified. The main implications concern the behavior of market leaders and, consequently, the antitrust approach to abuse of dominance (or monopolization) issues, but I will also derive implications for the antitrust approach to mergers and collusion.

The theory of endogenous entry and market leadership has shown that whether entry in a market is exogenous or endogenous makes a lot of difference for the way leaders behave (Etro, 2006a, 2008). In markets where entry is independent from the profitability conditions, market leaders can adopt accommodating strategies to increase prices or aggressive ones to exclude rivals, and their strategies can harm consumers. When entry is endogenously dependent on the profitability conditions in the market, the leaders always adopt aggressive strategies which typically do not harm consumers. For instance, a firm competing with a single rival could engage in accommodating pricing to increase mark ups, or could engage in predatory pricing to induce the exit of the rival, but a firm facing endogenous entry of competitors will ordinarily engage in aggressive pricing strategies without exclusionary purposes. As a second example, consider a monopolist in a primary market competing also in a secondary market: when the latter is characterized by a single rival, the monopolist may bundle its goods to monopolize also the secondary market, but when the secondary market is characterized by endogenous entry the only purpose of bundling can be the strengthening of price competition. Finally, a firm facing a single rival could adopt vertical restraints on its retailers or price discrimination strategies to soften price competition, but when the same firm faces endogenous entry of rivals these anti-competitive practices will not be in its interest. Of course, notice that efficiency reasons can still motivate the adoption of bundling, vertical restraints, price discrimination or other strategies. Therefore, the overall flavor of the endogenous market structures approach is reminiscent of the Chicago school, but the analysis is based on game theoretic foundations in line with the post-Chicago tradition.

The endogenous market structures approach delivers a related and strong result on horizontal mergers. As well known, even in the absence of cost efficiencies, these mergers are often profitable when entry is exogenous because they allow the merged entity to increase prices or restrict production so as to enhance profitability. These effects are counterproductive when entry is endogenous because any accommodating strategy attracts entry. Therefore, the only rationale for mergers in markets with endogenous entry must be a cost efficiency large enough to (more than) compensate the strategic disadvantages associated with the merger. In these cases, mergers are welfare improving. Similar results apply to cartels, that are ineffective whenever entry in the market is endogenous, unless the cartels act as leaders (in this last case, the cartels coordinate aggressive strategies aimed at increasing the market shares of their members through low prices, and their implementation is always sustainable and it does not even harm consumers).

It is clear that the relevance of these results depends on the relevance of the hypothesis that entry is endogenous in a specific market. One may argue that entry can be usually regarded as endogenous in the medium and long run, but not in the short run. If this is the case, and if antitrust policy is aimed at correcting distortions in the medium and long run (as opposed to short run distortions), then these results are potentially relevant.

Endogenous Market Structures and Globalization by J. Sutton: II Stackelberg Lecture (June 2008)

Stackelberg Leadership with Product Differentiation and Endogenous Entry: Some Comparative Static and Limiting Results by K. Žigić (2008).

Allowing for endogenous entry in the traditional Stackelberg setup with product differentiation, leads to reverting of the standard comparative static and limiting results. Unlike in the standard Stackelberg setup with barriers to entry, the leader's profit increases when the differentiation becomes lower. The reason is that competition becomes tougher when products become more alike, and consequently, fewer firms enter in equilibrium. On the other hand, increasing product differentiation towards its limit results in number of entrants tending to infinity and for very large market, the profit of the leader approaches zero. Thus market structure approaches monopolistic competition, rather than the standard monopoly outcome that occurs with exogenous number of followers.

Competition Policy and Market Leaders by I. Maci and K. Zigic (2008)

One of the key objectives of competition policy is to affect market structure and market conduct if they are deemed to be socially undesirable. When, for instance, market concentration exceeds a certain threshold, government usually undertakes measures to decrease the concentration by banning mergers or requiring large firms to divest. However, such an approach may under certain circumstances yield opposite outcome than desired. The reason is that traditional approach in which usually the height of Herfndhal-Hirschman index determines whether market concentration is "excessive" or not is often too rough and it does not lie on solid theoretical grounds (see more on this in Motta, 2004).

Based on the rigorous game theoretic analysis, Sutton (1991) and Etro (2007) demonstrated that high market concentrations is in fact an outcome of tough (both price and non-price) competition rather than the indicator of market power and lack of competitive forces when conditions of free (or more generally, endogenous) entry prevail. (Note that the assumption of free entry is the reasonable one in characterizing of the long run equilibria). Thus, shifting market structure and related market conduct away from market leadership may have undesirable social effects in the dynamic markets (like, for example, software market) characterized with huge investment in R&D and free entry. For instance, one way how the government can engineer such a shifts in a software industry is to deprive the leading firm of its patented and widely spread product or from its superior technology by forcing it to reveal the secret pieces of information to its competitors. By revealing, say, source code of the most used operating system (through compulsory licensing) a "dominant" firm might be, among other things, stripped of its leading market position. So in the longer run there will be firms of similar power competing in the market. In the terms of market conduct, this situation could be described as a change from Stackleberg leadership to an "ordinary" oligopoly of firms with more even power.

This paper aims to study a positive and normative aspect of the above situation in which dominant firm is deprived of its leading position by means of competition policy. Our analysis is motivated by the actual decision of European Commission (EC) recently confirmed by the European Court of First Instances, to impose a legal duty on a firm with a dominant position (Microsoft) to license its proprietary technology and intellectual property rights (IPR) to its competitors so that they can incorporate that very same technology into their own directly competing products. This verdict is based on the reasoning that industry-wide innovation will be boosted in the long-run if the leading firm is deprived of its exclusive intellectual property rights. More specifically, according to EC this is justified when, "on balance, the possible negative impact of an order to supply on dominant firm's incentives to innovate is outweighed by its positive impact on the level of innovation of the whole industry (including the dominant firm)." Thus, the EC decision seems to establish a new balancing test under which the EC can order compulsory licensing. However, it seems that there was no underlying economic analysis on the side of EC that would support the above claims. Therefore, this paper reconsiders this EC decisions by relying on relevant economic analysis of market leaders (Etro, 2007) and also by relying on an equilibrium refinement in the repeated games that focuses on outcomes Preferred by Efficient Players (Boone 2004).

The Unilateral Incentives for Technology Transfers: Predation (and Deterrence) by A. Creane and H. Konishi (2009, International Journal of Industrial Organization).

Joint production between rival firms often entails knowledge transfers without direct compensation, leaving the question as to why more efficient firms would give their rivals such an advantage. This article finds that such transfers are credible mechanisms to make the market more competitive so as to deter entry or force exit. The authors determine that with free entry such transfers are profitable and further it may be optimal to predate or deter every firm possible so that a market with many firms can become a duopoly. While consumers are harmed by such action, production efficiency normally increases sufficiently to cause welfare to increase.

When Market Competition Benefits Firms byJ. Ishida, T. Matsumura and N. Matsushima (2008).

A conventional wisdom in economics posits that more intense market competition, measured in almost any way, reduces firm profit. In this paper, we challenge this conventional wisdom in a simple Cournot model with strategic R&D investments wherein an efficient firm (dominant firm) competes against less efficient firms (fringe firms). We find that an increase in the number of fringe firms can stimulate R&D by the dominant firm, while it always reduces R&D by each of the fringe firms. More importantly, this force can be strong enough to compensate for the loss that arises from more intense market competition: the dominant firm’s profit may indeed increase with the number of fringe firms, quite contrary to the conventional wisdom. An implication of this result is far-reaching, as it gives dominant firms to help, rather than harm, fringe competitors. We relate this implication to a practice know as open knowledge disclosure, especially Ford’s strategy of disclosing its know-how publicly and extensively at the beginning of the 20th century.

Stackelberg Competition with Endogenous Entry by F. Etro (2008, The Economic Journal).

This paper studies market structures where one or more dominant firms have a competitive advantage on the other firms, technically a first mover advantage in the sense of Stackelberg (1934), but entry in the market is free. Such a market structure emerges in many markets 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 strategic advantage over the followers. While standard models of symmetric competition have been widely studied in presence of free entry in a Marshallian tradition, quite surprisingly standard models of Stackelberg competition have not.

The analysis of Stackelberg competition with free entry delivers a simple general result: leaders are always aggressive compared to the followers, while this is not the case in presence of barriers to entry. With a fixed number of firms the leader is mainly concerned about the reactions of the other firms to its own choices (but these reactions are opposite according to whether strategic substitutability or complementarity holds). However, when entry is free, the leader is mainly concerned about the effect of its own choices on the entry decision: an accomodating behaviour would be ineffective because (the induced) entry would make it unprofitable, while an aggressive behaviour limits entry and spreads a small mark up over a large market share.

Let us review the main applications of this result comparing markets characterized by barriers to entry, as duopolies, and by free entry. In a duopoly with competition in quantities the leader may produce more or less than the follower, but when entry of followers is free, the leader will prefer to produce more than each one of them, and, under weak conditions, will actually produce enough to completely deter their entry. In a duopoly with competition in prices, a leader would set higher prices than the follower, accomodating entry and raising mark-ups of both firms, but when entry of followers is free the opposite happens: the leader undercuts them and hence it sells more than each follower at a lower mark-up. Finally consider a patent race where firms invest in innovation: with barriers to entry a leader may invest more or less than the followers, according to the innovation technology, but under free entry, the leader always invests more than the other firms. I will show that all these results are robust to realistic extensions as the presence of multiple leaders or an asymmetry between leaders and followers.

Since any theory able to provide policy implications for antitrust analysis should address the role of market leaders, our model can be used for this purpose. It turns out that in all our applications, the role of market leaders is always beneficial as long as entry is free, while this is not the case when there are barriers to entry. More precisely, under quantity and price competition and in patent races as well, the aggressive strategy of the leaders improves the allocation of resources. Consequently, a possible implication is that fighting barriers to entry should be the priority for antitrust authorities, rather than reducing the market share of dominant firms: paradoxically, when entry is free, a market dominated by few leading firms with large market shares and positive profits is more efficient than a market without a clear leadership and many small firms earning no profits.

The model is strictly related with the old literature on entry deterrence associated with the socalled Bain-Modigliani-Sylos Labini framework and with the theory of contestable markets of Baumol-Panzar-Willig. However, even if these initial theoretical contributions took in consideration the effects of entry on the behaviour of market leaders, they were not developed in a coherent game theoretic framework and were substantially limited to the case of competition with perfectly substitute goods and constant or decreasing marginal costs (which not by chance, as we will see, are sufficient conditions for entry deterrence). A more recent literature started by the work of Dixit (1980) has developed a coherent theoretical framework but focusing on duopolistic games and without examining the role of endogenous entry on the behaviour of market leaders. This paper tries to provide a general theoretical foundation for some of the insights of the Bain-Modigliani-Sylos Labini analysis extending the old Stackelberg model to endogenous entry.

Endogenous Timing with Free Entry by A. Tesoriere (2007) and Endogenous Timing with Infinitely Many Firms by A. Tesoriere (2008, International Journal of Industrial Organization)

This paper considers a model of competition with free entry where firms decide not only whether or not to enter the market, but also their entry time. In the same spirit as the recent literature on endogenous timing, I address the issue of what order of play one should observe when firms are allowed to choose first at which period to enter the market and then, given the resultant timing structure, their output level. A common motivation of many studies in this area is that in the presence of either a first or a later mover advantage the sequence of moves should be dealt with as an equilibrium phenomenon instead of being exogenous, especially when firms are ex ante identical. Here I extend the criterion introduced by Hamilton and Slutsky (1990) for the two-period, two-firm case to encompass endogenous number of firms. The main features of the framework here are that (i) entry takes place until a new entrant expects non positive profits in equilibrium, and (ii) given a sequential pattern of moves in the product market, with possibly many firms moving at the same period, the output decisions of earlier movers are known to subsequent competitors. So, any possible sequential order of play gives rise to a hierarchical Stackelberg game where each firm takes the output of earlier and simultaneous movers as given while exactly predicting the strategies of later movers up to the period at which the free entry condition (i) is satisfied.

Three different patterns can a priori realize. The first case is simultaneous entry, where firms enter the market at the same period and induce a Cournot equilibrium with free entry. The second case is sequential entry in the sense of Prescott and Visscher (1977), where firms enter one at time, then play a sequential game with perfect information, and induce a subgame perfect Nash equilibrium (SPNE) with free entry. Beyond these two extremes, the third, more general case is that of a sequential timing structure with some firms moving at the same period. When choosing its entry period, each firm considers its SPNE payoff for the version of the market stage game that would obtain, that is the market stage game with timing structure defined by the firms’ timing decisions. The equilibrium of the whole game defines the number of firms active in the market, the production decisions of these firms, and the timing according to which production takes place. I consider the case of linear costs only. The results can be extended to the case of concave costs, but possibly do not hold in the presence of increasing marginal costs.

A key observation in this paper is that, with given number of incumbents, under the free entry assumption, early movers always prevent entry. This is because they anticipate that if entry was accommodated then the equilibrium price would not be larger than in the case of entry preemption. With linear costs these firms can do strictly better by producing the preemptive output themselves at the first stage. The fact that one Stackelberg leader with linear costs might preempt entry
is well recognized in the literature on industrial entry deterrence. Vives (1988) makes the interesting point that in a hierarchical Stackelberg model with sequential entry and given number of firms, the leader never accommodates entry of firms which will subsequently block further entry. More recently, Etro (2004) studies a free entry Stackelberg model with one leader. With linear costs, the leader prevents entry. Similar intuitions are already in Prescott and Visscher (1977).

As an intermediate result, this paper extends these findings to industries with many established firms, by showing that with linear costs and free entry, any given number of incumbents deters entry. What is remarkable is that, with n firms moving simultaneously at the first period and free entry in the subsequent periods, there always exists an equilibrium where only one incumbent produces the entry preventing output, the remaining (n − 1) firms produce no output, and the later movers do not enter the market. In addition, other configurations might be sustainable as equilibria, with either m firms producing the entry preventing output in aggregate and the remaining (n −m) firms producing 0, or with the n incumbents producing their Cournot output each and blockaded entry. No other equilibria exist.

Stackelberg Equilibrium with Many Leaders, U-shaped Average Costs, and Endogenous Number of Followers by A. Tesoriere (2008).

This paper features the equilibria of a Stackelberg model with U-shaped average costs, multiple leaders, and endogenous number of followers, with focus on entry preemption on the part of the leaders. It reviews and extends results derived in Etro (2007) for a more general class of games with multiple leaders and followers, and provides a full characterization of the reaction functions and of the equilibria for the particular case under focus.

Asymmetric Spillovers and Sequential Strategic Investments by J. Vanderkerckhove and R. De Bondt (2007, Economics of Innovation and New Technology).

The focus of this paper is on the consequences of asymmetric spillovers on the strategic investments in an oligopoly with leaders and followers. Both in the investment and output game, leaders move before the followers. Spillovers may occur between leaders and between followers and from leaders to followers. The consequences are detailed for:

- the comparison of leader and follower efforts;

- the comparison of investments with or without cooperation of leaders, followers or leaders and followers;

- other specific real world situations.

It is be argued that there are critical levels of spillovers that drive the relevant tendencies. They tend to depend in a complex way on the other parameters of the oligopoly. Still some clear tendencies emerge that can help to understand asymmetric leader-follower rivalry.

Persistence of Monopoly, Innovation, and R&D Spillovers: Static versus Dynamic Analysis by K. Zigic et al. (2007).

How good are monopolies for conducting innovation? Whether and when these innovations lead to persistence of monopoly? This kind of questions is not exactly new among economists, but they seem to be actual again judging by provocatively entitled ''Slackers or Pace-Setters: monopolies may have more incentives to innovate than economists have thought'' in the celebrated rubric ''Economics Focus'' of the May 2004 issue of “The Economist”. Apparently, there is a controversial role of market power and monopolies in creating innovations and the key to the answer lies in the underlying incentives to undertake innovations. The recent empirical evidence seems to support these Schumpeterian allegations from ''The Economist'' in a sense that there is a positive relationship between market power and intensity of innovation. Moreover, this evidence is, in fact, consistent with pre-emptive, strategic R&D investment by the leaders. As a consequence of such strategic behavior, there may be only one firm that survives in the market in the long run, but then this firm would display far more competitive behavior than standard monopolist. It would respectively generate higher flow of R&D, charge lower price and produce more.

There are many real-world examples of monopolistic or dominant firms that invest more in innovation and R&D than their rivals and that persists over long period of time. Here we could, for instance, mention AT&T as an example of such pattern. Founded in 1885, the company is one of the largest telephone companies and cable television operators in the world. After becoming a first long distance telephone network in the US, AT&T made huge investments in research and development. As a result, the company obtained near monopoly power on long distance phone services. Heavy investments in R&D together with aggressive behavior on the market allowed AT&T to obtain crucial inventions and to spread its near monopoly power on other markets. The company was also buying patents for significant innovations. Only after a suit against AT&T in 1982 followed by the breakup of the company into several local independent units called ''Baby Bells'' in 1984 the US telephone industry became competitive and other companies entered the market. While loosing part of its market power on the long distance telephone services, the company has continued its aggressive investments in R&D. For example, in 2004 AT&T introduced a facility allowing businesses to securely run their private networks without any interruptions on AT&T's leading global Internet Protocol network. This innovation assures the company to remain a leader in IP networking. Even AT&T characterizes itself as ''backed by the research and development capabilities of AT&T labs, the company is a global leader in local, long distance, Internet and transaction-based voice and data services''.

The above observations concerning the relation between innovativeness, leadership and market power motivate this analysis which aims to describe and analyze a particular setup in which the persistence of monopoly can arise in the long run. More specifically, this paper studies the situation in which the market leader undertakes pre-emptive R&D investment, (or, in other words, adopts ''strategic predation'' strategy) that eventually leads to exit of the follower firm or/and prevents or limits the entry of the new firms and we contrast this situation with the one in which the leader (within the same setup) ''accommodates'' the follower, that is, it co-exists with follower in a duopoly market structure. This comparison will enable to study both positive aspects of the two main strategies - accommodation and strategic predation - (like, for instance, which strategy yields higher R&D intensity or R&D stock) and normative aspect (social welfare implications) of the two resulting market structures - duopoly versus (constrained) monopoly.

The novel feature of this approach is in the introduction of an explicit dynamic model and in its contrast with its static (or quasi-dynamic) counterpart. Since strategic innovations are inherently dynamic phenomenon, the authors argue that suitable models aimed at capturing both accommodating and the pre-emptive or predatory behavior of the dominant firm should be explicitly dynamic. Furthermore, to emphasize the role of the leader they assume that the leader is the only one that invests in innovation while the follower imitates through R&D spillovers. (The importance of R&D spillovers, imitations and its economic implications is well and broadly documented in both theoretical and empirical literature). However, most of the theoretical models are static in nature and they focus on the accommodation strategies. That is, strategic predation is simply ignored or precluded by assumptions (so that it is never optimal). In such situations unilateral R&D spillovers create disincentives to invest in R&D and consequently hamper innovations. However, in the case when strategic predation is optimal, the economic implication of R&D spillovers is exactly opposite. They enhance the incentive to invest in R&D.

The paper demonstrates that contrary to the static set-up where (constrained) monopoly is usually marginal market structure (and is therefore often excluded from the analysis by assumption), in the dynamic setup, this market structure becomes more prevalent as the speed of adoption of the new technology increases and the efficiency of R&D process is high. Put together, these two facts yield a testable prediction in that the most propulsive innovative firms, that commercialize their investment in innovation quickly and efficiently (like, say AT&T, Microsoft, etc.), are the ones likely to use the strategic predation through investing large sums of money into innovative activity that in turn, help them to attain monopoly or near monopoly position. As for the social welfare considerations, strategic predation as dominant market strategy is socially preferable as well since it leads to both higher consumer surplus, and to higher social welfare generated despite the fact that only one firm (the leader) remains in the market in the long run. This all bears important competition policy implications. First, the size of market share per se might not be sufficient condition for a legal offence and second the monopoly pricing and consumer protection, that is a usual concern of the competition and antitrust policy, is not an issue in the above setup. The leader threatened by potential (re)entry of the follower keeps price at the notably lower level than the monopoly price.

Entry in a Stackelberg Perfect Equilibrium by A. Mukherjee (2007).

This paper considers welfare effects of entry when the incumbent firm behaves like a Stackelberg leader in the product market. In contrast to previous work (Klemperer, 1988, Journal of Industrial Economics), it shows that entry may always increase welfare. Using a general demand function, the paper shows the condition for welfare improving entry.

Endogenous Market Structures and Antitrust Policy by F. Etro (2007).

This article derives antitrust implications for markets where entry can be regarded as endogenous (contrary to most analysis within the post-Chicago tradition). Many applications concern issues of abuse of dominance. Endogenous entry requires a wide revision of our understanding of the role of incumbents in pricing, producing in the presence of network externalities and multi-sided markets, bundling products, price discriminating and delegating to retailers through vertical restraints: when entry is endogenous, leaders adopt aggressive strategies without exclusionary purposes and without affecting welfare negatively. Endogenous entry has also implications for the analysis of mergers (that take place only if create enough cost efficiencies and do not harm consumers), the evaluation of collusive cartels (that are unfeasible in markets where entry is endogenous) and state aids for exporting firms (which are always unilaterally optimal for international markets with free entry). The spirit of the policy recommendations of the Chicago school is broadly supported by our analysis in a solid game-theoretic framework.

Externality and Timing of Entry in Oligopoly Models by S. Basher and A. Saber Mahmud (2007).

Using models of imperfect competition, this paper analyzes endogenous timing of entry with the possibility that firms learn from the actions of others. Under sequentially entry, the late-moving firm pays a lower entry cost due to positive externalities that arise from the first firm's entry. In the case of two symmetric profit-maximizing private firms, the authros find that multiple equilibria which stem from the trade-off between entering early or late. When the analysis is carried out with a welfare-maximizing public firm and a profit-maximizing private firm, they show that equilibrium outcome depends on the size of cost inefficiency parameter of the public firm. Finally, the paper also conducts an analysis where the public firm acts as a strategic initiator of the costly initial expenditure before leaving the market to the private firms.

Aggressive Leaders by F. Etro (2006, The Rand Journal of Economics).

In many market settings, a firm can have an incentive to undertake preliminary investments to gain advantage over its competitors. For instance, when Cournot competition takes place between two firms, one of them would usually gain by overinvesting to reduce costs, which allows it to be aggressive in the market; expanding production and inducing its rivals to produce less. However, under Bertrand competition the same firm would prefer to underinvest in cost reductions so as to be accommodating; increasing its price so as to induce its rivals to raise price. More generally, Fudenberg and Tirole (1984) and Bulow, Geanakoplos and Klemperer (1985) have shown that, when a preliminary investment increases marginal profitability, a firm would like to overinvest under strategic substitutability and underinvest under strategic complementarity: the first "top dog" strategy leads to aggressive behaviour in the market (higher production or lower price), while the second "puppy dog" strategy induces accommodating behaviour (lower production or higher price).

This paper shows that when entry is endogenous, a firm would always like to undertake investments to be aggressive in the market; that is to expand production under Cournot competition and decrease prices under Bertrand competition. For instance, a leader will always find it optimal to overinvest in cost reductions (or adopt a similar "top dog" strategy) to be able to produce more and to reduce its price below the price of its competitors. This outcome emerges in many other contexts with surprising results about investments in quality improvements, production of complementary goods, dumping to exploit a learning curve or create network externalities, bundling of goods and so on.

In any market where entry is free, the leader always overinvests to gain a strategic advantage and conquer a larger market share. However, this results in a reduction in prices with a net gain for the consumers! This happens under any form of competition (including in prices and in production levels) as long as entry for the competitors is free. Only when this is the case, the fear of the competitors induces the leader to be aggressive: its best strategy requires reducing costs, improving product quality, engage in a lot of advertising, produce complementary products and so on. This allows the leader to lower its price, gain market share and gain from a reduction in the average costs of production, but it also disciplines the competitors and keeps prices at a low level, with unambiguous benefits for the society.

This implies that a dominant position obtained through strategic investments can be the consequence of a competitive market environment and not the result of barriers to entry. The practical implications for industrial policy are the opposite than in the traditional industrial organization: a leadership in a market is not in itself a sign of an inefficient market structure or of lack of competition. What matters is whether there is a free access and, if this is the case, a market leadership is just the sign of a more efficient organization of the market. Actually, the new industrial organization provides a simple way to rank markets structures in terms of welfare. The worst one is characterized by barriers to entry; promoting entry in the market induces superior outcomes; but the best outcome emerges when entry is free and one or few firms are dominant. That's why anti-trust authorities should shift their priorities and move ahead the promotion of free entry rather than the fight against market leaders.