Dominant Firms, Barriers to Entry Capital and Entry Dynamics

Recent literature in Industrial Organization has shown that the threat of entry limits the price setting power of dominant firms and stimulates the incumbents to increase innovations ---both leading to welfare improvements. On the other hand dominant firms as incumbents strive to build up entry preventing capital. In such an environment of heterogeneous firms, we study the dynamics of competition as suggested in an earlier paper by Brock (1983). When dominant firms face a threat of the competitive fringe’s entry in the industry they, therefore, will have an incentive to prevent it. Investing into barriers to entry capital through engaging in production activities with increasing returns and high adjustment cost of investment as well as through advertising, lobbying and patents the dominant firm can create thresholds above which fringe firms cannot induce price competition and stimulate innovations. The dominant firms thus face two types of investment: Entry-deterring investment and investment in physical capital for production activities. Depending on how the competitive fringe responds to the first type of investment, complex dynamics, multiple steady states and thresholds, separating different domains of attraction, may emerge. Since the effectiveness of entry-deterring investment depends in part on regulatory rules set and enforced by antitrust institutions, we show how an antitrust and competition policy can be designed that may prevent the build up of entry preventing capital strengthening incentives for price competition and innovations