Judo Economics

Topics: Cost, Economics, Microeconomics Pages: 11 (2622 words) Published: January 30, 2013

Judo Economics in Markets with Asymmetric Firms

Daniel Cracau

Working Paper No. 2/2013

Impressum (§ 5 TMG)
Otto-von-Guericke-Universität Magdeburg
Fakultät für Wirtschaftswissenschaft
Der Dekan
Verantwortlich für diese Ausgabe:
Daniel Cracau

Otto-von-Guericke-Universität Magdeburg
Fakultät für Wirtschaftswissenschaft
Postfach 4120
39016 Magdeburg

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ISSN 1615-4274

Judo Economics in Markets with Asymmetric Firms
Daniel Cracau1a

University of Magdeburg, Faculty of Economics and Management

I study a game with one market incumbent and a small entrant in a duopoly with perfectly substitutable products. Firms face a sequential Bertrand competition. Limiting the initial capacity (Judo economics) is a plausible entry strategy for the small firm. If we, however, introduce asymmetry in production cost or product quality, capacity limitation can become obsolete. I derive thresholds as regards the cost and quality differences for the entrant’s choice to voluntarily limit the production capacity in equilibrium. I study a market entry game with price competition and perfectly substitutable products. Limiting the initial capacity (Judo economics) is a plausible entry strategy. I show that under asymmetry in production cost or product quality, capacity limitation can become obsolete.

Keywords: Sequential Bertrand Competition, Judo Economics,
Asymmetric Firms, Cost, Quality
JEL: D43, L11
1. Introduction
Judo economics as an entry strategy was first introduced in Gelman and Salop (1983). They show that a market entrant can use a capacity limitation to successfully survive in a Bertrand competition with homogeneous goods. For the market incumbent, accommodating entry turns out to be the profit maximizing response towards a Judo entrant. Rather than cutting down prices for the whole market, the incumbent allows the new entrant to serve 1

Correspondence to: Daniel Cracau; mailing address: University of Magdeburg, Faculty of Economics and Management, Chair in E-Business, Universit¨tsplatz 2, 39106 Magdea burg, Germany; telephone: +49-391-67-11359, e-mail: Cracau@ovgu.de

a small niche but sustains the power to serve the residual market as a monopolist. Meanwhile, the idea of Judo economics has been further elaborated in the economic literature. Empirical work has reported that Judo entrants are more likely to survive competition and incumbents respond less aggressively towards Judo entrants (Thomas, 1999). Also experimental results have shown that Judo economics works in the original setting (Cracau and Sadrieh, 2013). Theoretical work has focused on Judo Economics in more or less symmetric settings (Sørgard, 1995; Allen et al., 2000; D´ et al., 2009). If any, only ıaz

a cost advantage for the incumbent is considered. However, it is arguable that in some industries, entrants emerge with a technological innovation that gives them a cost or a quality advantage. The purpose of this article is to apply the idea of Judo Economics to a wider range of settings. I will allow for asymmetries in the firms’ cost structure and the consumers’ willingness to pay.

2. Model preliminaries
I initially study two firms i = 1, 2 in a sequential Bertrand competition with firm 1 being the first moving entrant and firm 2 being the second moving market incumbent.
Assumption 1. Products are perfect substitutes with different quality levels. Consumers’ willingness to pay for firm i’s product is wi . Assumption 2. Total market demand D is fixed.
In the first stage of the game, the entrant decides on his price p1 ≤ w1 and a capacity limitation 0 < k ≤ D. Then, the incumbent decides on her price p2 ≤ w2 , adjusting output accordingly.2 We, thus, assume that the incumbent has no capacity limitation.

Assumption 3. Consumers’ preferences are lexicographic. Consumers buy from the firm which offers the highest consumer net benefit βi...

References: Allen, B., Deneckere, R., Faith, T., Kovenock, D., 2000. Capacity precommitment as a barrier to entry: a bertrand-edgeworth approach. Economic
Theory 15, 501–530.
Boccard, N., Wauthy, X., 2009. Entry accommodation under multiple commitment strategies : judo economics revisited. CORE Discussion Papers
2009050, Universit´ catholique de Louvain, Center for Operations Research
Cracau, D., Sadrieh, A., 2013. Coexistence of small and dominant firms in
bertrand competition: judo economics in the lab
Furth, D., Kovenock, D., 1993. Price leadership in a duopoly with capacity
constraints and product differentiation
Milgrom, P., Roberts, J., 1982. Limit pricing and entry under incomplete
information: an equilibrium analysis
Motta, M., 1993. Endogenous quality choice: price vs. quantity competition.
Sørgard, L., 1995. Judo economics reconsidered: capacity limitation, entry
and collusion
Thomas, L. A., 1999. Incumbent firms’ response to entry: price, advertising,
and new product introduction
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