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Scope economies, entry deterrence and welfare

By  |  September 26, 2012

Cesaltina Pacheco Pires (CEFAGE-UE, Departamento de Gestao, Universidade de Evora) and Margarida Catalao-Lopes (CEG-IST, Instituto Superior Tecnico, Technical University of Lisbon) observe Scope economies, entry deterrence and welfare.

ABSTRACT: This paper develops a model where the incumbent may expand to a second related market so as to signal the existence of scope economies and deter potential entry. We show that the incumbent only expands to another market when scope economies are large enough. Thus expansion is indeed a signal of larger economies of scope and, for certain parameter values, it leads to entry deterrence. We show that the perfect bayesian equilibrium may involve entry accommodation, entry deterrence or a mixed strategy equilibrium. We investigate the welfare implications of prohibiting an entry deterrent expansion. In our model, such prohibition would always decrease consumer surplus. The welfare impact of preventing entry deterrence is ambiguous but negative for many parameter values.