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An experiment on strategic capacity reduction

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  • Mikhael Shor

    (University of Connecticut)

Abstract

A firm may strategically decrease capacity to gain bargaining power over its suppliers. Equilibrium models of competition imply that the incentive to reduce capacity to gain buyer power is small because the buyer captures all available surplus by excluding even a single supplier. However, these models can rest on behaviorally untenable actions prescribed to suppliers in equilibrium. In this paper, we test this theory using a laboratory experiment in which subjects compete to supply a single firm. We find that as capacity decreases, so do suppliers’ price requests, but according to a pattern quite different from equilibrium predictions. We find that a buyer has incentive to exclude at least 30% of available suppliers. This result calls for greater antitrust oversight and offers a behavioral explanation for observed reductions in capacity. JEL Classification: C78, C90, L13 Key words: Strategic capacity reduction, Bargaining power, Ultimatum games, Behavioral economics

Suggested Citation

  • Mikhael Shor, 2008. "An experiment on strategic capacity reduction," Working papers 2012-22, University of Connecticut, Department of Economics.
    • Handle: RePEc:uct:uconnp:2012-22
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    References listed on IDEAS

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    More about this item

    Keywords

    strategic capacity reduction; bargaining power; ultimatum games; behavioral economics;
    All these keywords.

    JEL classification:

    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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