Entry, Pricing, and Product Design in an Initially Monopolized Market
University of Chicago and National Bureau of Economic Research
We analyze entry, pricing, and product design in a model with differentiated products. Market equilibrium can be “separating,” with multiple sellers and a sorting of heterogeneous consumers across goods, or “exclusionary,” with one seller serving all customer types. Entry into an initially monopolized market can occur because of cost reductions or product improvements, but entry need not lower the incumbent’s price, improve efficiency, or raise consumer welfare. Postentry design incentives favor a softening of price competition and stronger market segmentation, whereas exclusionary design changes typically raise consumer welfare. Potential, as distinct from actual, entry always benefits consumers.
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We thank Sherwin Rosen, Judy Chevalier, David Evans, Drew Fudenberg, Bernard Reddy, Lars Stole, Jean Tirole, an anonymous referee, and workshop participants at Brown University, the University of Chicago, the University of Missouri, Texas A&M, and the U.S. Department of Justice for helpful comments on earlier drafts. We also thank Walter Oi, our discussant, and other participants in a conference held in May 2001 at the University of Chicago to honor the memory of Sherwin Rosen. We gratefully acknowledge research support from Microsoft Corporation. Errors are our responsibility.