Entry Deterrence : The Case of a Buyer with Market Power

The model considers a seller operating under the threat of an arbitrarily large number of unknown potential entrants and facing a strategic buyer. It is shown that the seller's Nash best response function slopes downward in price-output space, while that of the buyer slopes upward. The Nash equilibrium may be associated with a lower probability of entry than the equilibrium at which the buyer behaves non-strategically. With the buyer as the Stackelberg leader, the price is shown to decrease relative to that at the Nash equilibrium, but the probability of entry may rise or fall. The intuition behind the model is that the buyer faces the choice of dealing with a known incumbent seller or an unknown potential entrant and can affect the probability of entry by making the market more or less lucrative. The buyer's incentive to encourage entry by raising purchase quantity increases as the incumbent charges a higher price. Similarly, the seller's incentive to discourage entry by lowering price increases as the buyer announces larger purchase quantity