Entry Deterrence

Game Theory · Axiom Academy

1. The Market Entry Game Setup The entry deterrence game involves two players making sequential decisions: Potential Entrant: Decides first whether to Enter or Stay Out of the market Incumbent: If entry occurs, decides whether to Accommodate (share the market peacefully) or Fight (engage in aggressive competition) The sequence matters: the entrant moves first, knowing the incumbent will observe this decision before responding. Consider a typical payoff structure (Incumbent, Entrant): Stay Out: (10, 0) - Incumbent enjoys monopoly profits, entrant gets nothing Enter → Accommodate: (5, 5) - Both firms share the market profitably Enter → Fight: (0, -2) - Price war hurts both, especially the entrant Notice that if entry occurs, the incumbent prefers to accommodate (5) rather than fight (0). Fighting is costly for everyone, but especially devastating for the new entrant. 3. When Deterrence Fails: Non-Credible Threats Suppose the incumbent threatens: "If you enter, I will fight!" Is this threat believable? If entry has already occurred, the incumbent faces: Accommodate (5) vs. Fight (0) Rational choice: Accommodate, earning 5 instead of 0 The entrant, anticipating this, compares: Enter and get 5 vs. Stay Out and get 0 Rational choice: Enter, earning 5 4. Making Threats Credible: Capacity Commitment How can an incumbent make the fight threat credible? By committing to actions that change the payoff structure. Invest heavily in excess production capacity before entry decision

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