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Excess Capacity and Collusion

Carl Davidson and Raymond Deneckere
International Economic Review
Vol. 31, No. 3 (Aug., 1990), pp. 521-541
DOI: 10.2307/2527159
Stable URL: http://www.jstor.org/stable/2527159
Page Count: 21
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Excess Capacity and Collusion
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Abstract

In this paper, we analyze a restricted class of equilibria in the dynamic model of Benoit and Krishna (1987) in which firms choose their scale of operation before engaging in a repeated game of price competition. Benoit and Krishna established that all firms carry excess capacity in all collusive equilibria. As we are interested in the relationship between excess capacity and collusion in price, we examine equilibria in which firms tacitly collude in price but not in investment decisions. If we further restrict attention to equilibria that are Pareto undominated within this class of "semi-collusive" equilibria, we find that capacity levels and collusion both increase if either interest rates or the cost of capacity fall. Increases in the interest rate reduce the capitalized value of the losses due to retaliation, thereby making it more difficult to support collusion. As excess capacity is used to support collusive outcomes, less capacity is needed if less collusion results.

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