A Maskin's IO paper

Original article (link) posted: 30/10/2005

Maskin (1999) “Uncertainty and entry deterrence” Economic Theory, 14

A model where capacity installation by an incumbent firm serves to deter others from entering the industry is considered. The paper shows that uncertainty about demand or costs forces the incumbent to choose a higher capacity level than it would under certainty. The intuitive reason is explained in Introduction, which is stated as follows;

To deter entry, the incumbent must install enough capacity so that, if entry occurred, the entrant’s profit would be zero (or negative). Under certainty, the incumbent will install no more capacity than it would use were entry to occur. With uncertainty, when demand is high, an incumbent that has installed the certainty level of capacity still continues to produce at capacity; price simply rises to reflect the higher demand. But, when demand is low, the incumbent will wish to produce at less than full capacity. This means that the fall in price when demand is low is not so large as the rise in price when demand is high, and so if the entrant’s is zero under certainty, it is positive with certainty. To deter entry, therefore, the incumbent must increase capacity above the certainty level to ensure that when demand is high it produces enough to drive the entrant’s expected profit back down to zero.


Matching and Market

I found insightful comments on the relationship between matching theory and market economy (more specifically, general equilibrium) in the following paper:
Vincent Crawford (1991), "Comparative Statics in Matching Markets" Journal of Economic Theory, 54: 389-400.
Perhaps the most important advantage of the matching approach is its robustness to heterogeneity. A traditional competitive equilibrium cannot exist in general unless the goods traded in each market are homogeneous, because all goods in the same market must sell at the same price. A traditional model of a labor market with the degree of heterogeneity normally encountered therefore has the structure of a multi-market general equilibrium model. But because the markets in such a model are very thin, the usual arguments in support of price-taking are strained. The theory of matching markets replaces this collection of thin markets with a single market game, in which the terms of partnerships are determined endogenously, along with the matching, via negotiations between prospective partners. Gale and Shapley's notion of stability(*), suitable generalized, formalizes the idea of competition, and thereby makes it possible to evaluate the robustness of traditional competitive analysis to heterogeneity. (Stable outcomes in matching markets can in fact be viewed as traditional competitive equilibria when prices are allowed to reflect the differences between matches; see, for example, Shapley and Shubik, 1972(**))

The author, Vince Crawford, who is known as a leading researcher in game theory has written a few influential papers on matching theory. Especially, the following two are of great importance since they initiated the area of (many-to-one) matching with monetary transfers.
"Job Matching with Heterogeneous Firms and Workers"
with Elsie Marie Knoer, Econometrica, Vol. 49(2): 437-450, 1981.
"Job Matching, Coalition Formation, and Gross Substitutes"
with Alexander S. Kelso, Jr., Econometrica, Vol. 50(6): 1483-1504, 1982.

* Gale and Shapley (1962) "College Admissions and the Stability of Marriage" American Mathematics Monthly, 69: 9-15.
** Shapley and Shubik (1972) "The Assignment Game. 1. The Core" International Journal of Game Theory, 1: 111-130.