Strategic Investment and Market Integration



integrated markets should be expected to be less concentrated. Hence, the issue of market-linkages
is important for any theory of market integration.

This paper considers a market situation described as a multi-stage game, where the incumbent
Hrst selects a global capacity, then competes with a number of entrants determined at the local level.
In this respect, this model di
ffers from most previous studies of multi-market interaction, where
it is often assumed that firms are allowed to make decisions at the multi-market level exclusively,
referred to as the integrated market hypothesis, or at the local level, referred to as the segmented
market hypothesis.4

In the model presented in this paper, each firm is assumed to exhibit a symmetric Leontief
technology with a fixed unit-cost of production. Furthermore, demand is considered to be inde-
pendent between markets and firms compete in strategic substitutes in the last stage of the game.
The incumbent firm is free to redistribute its global capacity between di
fferent markets. Hence,
there is a strategic link between di
fferent markets.5

The possibility to redistribute global capacity between markets makes entry-deterrence more
di
fficult and more costly than in a single-market game. To deter entry, the multi-market firm must
install capacity beyond the level required in a single-market game.6 Interestingly, the per-market
capacity installed to deter entry can be strictly larger than the largest subgame-perfect investment
in the single-market game. However, no capacity will be left idle in equilibrium.7

4Venables (1990) and Ben-Zvi and Helpman (1992) are two exceptions. In their models, capacity decisions are
made on an integrated basis and other decisions, e.g. price and sales decisions, on a national basis. The model in this
paper closely resembles Venables’ as well as Ben-Zvi and Helpman’s models in its attempt to analyze the importance
of investment when capacity can be used on a multi-market level, while sales decisions are taken on a local basis.

5See Witteloostuijn and Wegberg (1992), for an extensive summary on multi-market competition models where
existing
firms are potential entrants. In particular, Bulow, Geanakopolos and Klemperer (1985) present a multi-
market model relating to our analysis. They study a multi-market game where two
firms compete in one market,
but where one of the
firms is a monopolist in a second market. If the two markets exhibit joint economies, then
a positive shock in one market has positive e
ffects on entry deterrence in the other market, provided that the
products are strategic substitutes or strategic complements. In our model, however, the unit-cost is
fixed and Bulow,
Geanakopolos and Klemperer’s analysis does not apply.

6This paper is not concerned with the relative profitability of entry deterrence and accomodation. In Ganslandt
(1997), it has been shown that entry deterrence is pro
fitable, if sufficient conditions are satisfied.

7It should be noted that these results do generally not hold. In a similar two-firm, two-stage game with iso-elastic



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