Closer look market

One assumption of the static limit price model is that the potential entrant/ fringe firm expects the dominant firm to maintain output in the face of entry. We used this assumption to draw a residual demand curve for the potential entrant Figure 4 – 1. The entrant may very well expect different behavior from the dominant firm. It may expect the dominant firm to expand its output and lower its price in the face of entry in order to preserve market share this was AMXCO’s reaction to entry by Vebco, in the first case study. If the entrant expects the dominants firm to expand curve closer to the origin than suggested by Figure 4 – 1. All else equal, a smaller residual demand will make entry less likely.

In other circumstances, the entrant may expect the dominant firm to restrict output after entry and cooperate to maintain a high price and profit this is not a bad description of Saudi Arabia’s behavior in the first few years of OPEC control of world oil market. Then the entrant will figure on a residual demand curve further away from the origin than figure 4 – 1 suggests. All else equal, a greater residual demand will make entry more likely. The general point is that weather or not an entrant will come into a market, and weather or not a fringe firm will try to expand, will depend as much on how it expects a dominant firm to react as on how much it sees a dominant firm producing. This is an important factor in the analysis of oligopoly, and we will return to it in chapter 5.

If there are several potential entrants or fringe firms, each will have to consider the likely actions and reactions of all of the others, not just those of the dominant firm. Potential entrants may hesitate to come in if they think they will have to share the residual demand curve with other potential entrants.