Date of Award
Doctor of Philosophy (PhD)
Matthew S. Lewis
Patrick L. Warren
Babur De los Santos
Frederick A. Hanssen
My dissertation examines price responses to entry threats in oligopoly markets. In the first chapter, I theoretically demonstrate that two possible motivations can cause incumbent oligopolists to lower prices in response to a potential entrant's appearance: one is strategic entry deterrence, and the other is a breakdown in tacit collusion. Previous studies have analyzed pre-entry price cutting as an entry-deterrence strategy because, under incomplete information, it may signal to the potential competitor that entry would be unprofitable. When it comes to oligopoly markets, a breakdown in tacit collusion can also lead to such a price response. Oligopoly firms have the possibility to tacitly coordinate prices higher than their competitive level. However, as the threat of future entry decreases the relative payoff of coordination, they may reduce the price level maintained in collusion.
Even though pre-entry price cutting is the common reaction of both motivations in oligopoly, those two can be differentiated in terms of reduction patterns across the likelihood of entry. In the first chapter, I construct an infinitely repeated game in which two incumbent firms choose prices with the possibility of tacit collusion, expecting an entrant appears to make one-shot entry decision. When strategic entry deterrence is impossible so that pre-entry price cutting is only driven by a breakdown in tacit collusion, the model suggests the magnitude of the pre-entry price cuts monotonically increases as entry is more likely. On the other hand, the size of the pre-entry price cuts to deter entry is non-monotonic across the likelihood of entry when strategic entry deterrence is the underlying motivation.
Relying on the first chapter's testable predictions, I empirically examine the underlying motivation of pre-entry price cutting in the U.S. passenger airline markets. At the beginning of the second chapter, I estimate oligopolists' pre-entry price cuts when they encounter Southwest Airlines as a potential entrant. To test the monotonicity of the price reductions, I employ a two-stage regression model. In the first stage, a regularized logistic regression is used to predict Southwest's entry probabilities. In the second stage, I formulate price changes after the entry threat as a function of the predicted probability of entry and test whether the coefficients related to running gradients imply the size of pre-entry price cuts changes monotonically or non-monotonically. In conclusion, responses to Southwest's entry threat appear to result from a breakdown in tacit collusion. Incumbent carriers are shown to cut pre-entry prices further when Southwest's entry is more likely, consistent with the testable prediction of a breakdown in tacit collusion rather than strategic entry deterrence.
As an extension of the second chapter, the third chapter employs incumbent carriers' price distribution (particularly percentiles of ticket fares) to test the motivation of pre-entry responses. The basic idea is to compare how incumbents adjust their higher fares (paid by business travelers) and their lower fares (paid by leisure travelers) in response to a threat of entry. To this end, quantile regressions are used to show fare distributions change after Southwest becomes a potential entrant. It turns out that compared to the lower quantiles of fares, incumbents discount more on the higher quantiles of fares when incumbents are threatened by Southwest's potential entry. Based on the second chapter's motivation tests, I show that such price reductions of incumbent monopolists and oligopolists exhibit more consistent patterns with an attempt to deter entry and a breakdown in tacit collusion, respectively.
Shin, Jaejeong, "Essays on Response to Entry Threats" (2021). All Dissertations. 2786.