Strategic Investment and Market Integration

the domestic market. The local strategy is manufacturing of goods adapted to local preferences,
i.e. products which can be used by consumers in a specihc market only, and the global strategy is
production of a standardized good, which can be used by consumers in all markets. If the cost of
adjusting the adapted products in the post-entry game is sufficiently high, the local strategy can
successfully deter entry.

Third, market commitment can be induced by network lock-ins. The producer can introduce
local standards, which assign capacities to a specihc market. In this case, a global strategy is a
standard common to all markets.

Thus, the model of endogenously determined multi-market production potentially applies to
many different market conditions.

7 Price Competition in Differentiated Goods

Having shown that multi-market competition obstructs the incumbent’s possibilities to deter entry
if firms compete in strategic substitutes, we will now show that strategic complements give the
same result, if sufficient conditions apply.

An incumbent commit to a global capacity for two markets in the first stage. A potential
entrant in each market, called player t, observes the incumbent’s capacity and then chooses to
enter or stay out. If player t enters market t, the incumbent and the entrant both choose prices
for their respective variety of the differentiated good.

We use the Shubik (1980) system of demand functions where the demand for variety i in market
t is given by

x^lt = ¹ [^{α - b} (Pt + 9 (pt ^- Pt))] ,                             ⁽¹¹⁾

where n is the total number of active firms in the local market, p_t is the average price in the local
market and 9 is a measure of substitutability between products. Assume that the parameters of
the model satisfy some restrictions, a ≥ b ≥ c, and that the degree of substitutability is not too
large, 9 ≤ 2.

Consider a situation where entry deterrence is possible in the single-market game and the
entrant makes zero profit in a subgame with a nonbinding capacity constraint for the incumbent.

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