Excess Capacity and Pricing in Bertrand-Edgeworth Markets: Experimental Evidence

Abstract

We conduct experiments testing the relationship between excess capacity and pricing in BertrandEdgeworth duopolies and triopolies. We systematically vary the experimental markets between small amount of excess capacity (suggesting monopoly) and no capacity constraints (suggesting perfect competition). Controlling for the number of firms, higher production capacity leads to lower prices. However, the decline in prices as industry capacity rises is less pronounced than predicted by Nash equilibrium, and a model of myopic price adjustments has greater predictive power. With higher capacities, Edgeworth-cycle behavior becomes less pronounced, causing lower prices. Evidence for collusion is limited and restricted to low-capacity duopolies. * Financial support from the Nuffield Foundation (Grant number SGS/36496) is gratefully acknowledged. We thank Tim Miller for programming the software and helping running the sessions. We are also grateful to participants at seminars at the University of Exeter, Universidade do Minho, the University of East Anglia's conference on Cartels and Tacit Collusion, and the Portuguese Economic Journal 2009 meeting, for insightful comments and suggestions.

Choosing not to compete: Can firms maintain high prices by confusing consumers?

“…There is then a constant cycle of price wars leading to low prices, which are followed by abrupt unilateral increases in prices. Prices rise like a rocket but fall like feathers (Tappata, 2009), as happens in Edgeworth price cycles (Doyle, Muehlegger, & Samphantharak, 2010;Fonseca & Normann, 2013;Kruse, Rassenti, Reynolds, & Smith, 1994;Maskin & Tirole, 1988;Noel, 2015Noel, , 2008. Figure B3 shows an example of such best response dynamics in the triopoly when = 50% and = 20%.…”

“…Suppose that firms best respond to the strategies other firms adopted last period (Fonseca & Normann, 2013;Fudenberg & Kreps, 1993;Matsui, 1992;Mäs & Nax, 2016). If there is no differentiation ( = 0), then firms lower prices until prices equal zero.…”

Handbook of Game Theory and Industrial Organization, Volume II

“…This theoretical market power is found to significantly raise prices in the experiments. Fonseca and Normann (2013) vary capacity levels and the number of market competitors. They find, consistent with Kruse et al (1994), that higher capacities lead to lower prices and that price movements over time are more in line with the notion of Edgeworth cycles than with the static Nash equilibrium.…”

Oligopoly Experiments in the Current Millennium

“…Price dispersion can be rationalized if one takes sellers to be capacity‐constrained. This assumption is often maintained in posted‐offer pricing experiments and has as a consequence that rather than pricing at marginal costs, sellers use a mixed strategy in equilibrium (see, for example, Davis and Wilson, , , ; Davis et al ., , ; Davis, ; Fonseca and Normann, ). Alternatively, products may look identical at the surface, but are in fact differentiated due to, for example, differences in location, advertising or customer service.…”

“…(), who ran an experiment where it is costly for buyers to search for the seller with the lowest price. Perhaps the strongest evidence for Edgeworth cycles comes from a Bertrand pricing experiment reported by Fonseca and Normann (). Fonseca and Normann vary the extent of excess capacity and number of firms in the market (2 and 3) and show that as capacity decreases, dynamics correspond closer to Edgeworth price cycles.…”