Journal of Economic Behavior Organization Vol. 41 2000 147–157
Quantity precommitment in an experimental oligopoly market
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Astri Muren
Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden Received 14 February 1997; accepted 12 July 1999
Abstract
The paper describes an experiment designed to test if the equilibrium in a market characterized by capacity precommitment followed by price competition, as in the Kreps and Scheinkman model,
conforms with the outcome predicted by that model, which is that capacities coincide with Cournot output levels. Sessions were run with capacity precommitment in inexperienced and experienced
triopoly markets. The conclusion is that with inexperienced subjects capacity choices are more rivalistic than the model suggests, but in line with those of the Cournot experiments by Fouraker
and Siegel. With experienced subjects capacities are quite close to the prediction of the Kreps and Scheinkman model. ©2000 Elsevier Science B.V. All rights reserved.
JEL classification: C92; D43; L13 Keywords: Capacity precommitment; Kreps–Scheinkman model; Oligopoly experiment
1. Introduction
The choice of a model to describe competition in oligopoly markets is an important issue in industrial economics and its applications. The two main candidates are the Bertrand and
the Cournot models, which share the advantage of being analytically tractable. However, the two models give quite different equilibrium predictions, which implies that in many
applications the choice of model will have a significant influence on the results.
In the Bertrand model firms set prices under the assumption that other firms keep their prices constant. When products are homogeneous, the equilibrium price will be equal to
the marginal cost of at least one of the firms. This means that in the Bertrand model the
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Communicated by Dr. R. Day 0167-268100 – see front matter ©2000 Elsevier Science B.V. All rights reserved.
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148 A. Muren J. of Economic Behavior Org. 41 2000 147–157
degree of competition increases from zero to its maximum level already when the number of firms increases from one to two.
In the Cournot model, where quantity of output is the strategic variable, the number of firms plays a role in that the equilibrium price goes down when additional firms enter,
which seems intuitively reasonable. The problem lies in the theoretical motivation for the equilibrium — it would seem appropriate for any oligopoly model to let firms set prices
rather than just output levels.
Kreps and Scheinkman 1983 formulated a two stage model where firms first choose production capacity and then, in stage two, set their prices. Under certain circumstances
the equilibrium in this model will be identical to the Cournot equilibrium. Kreps and Scheinkman’s theoretical result integrates the Bertrand price setting model with the Cournot
model of quantity competition, and provides a rationale for using the Cournot model to de- scribe an industry with steeply increasing marginal costs, i.e. where the capacity choice is
a binding constraint for the firm, while the Bertrand model would be more suitable for an industry with a technology such that the marginal cost of production increases slowly with
output.
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Testing the Kreps and Scheinkman model could provide useful information for policy makers on the appropriateness of the Cournot model.
One experimental test of the Kreps and Scheinkman hypothesis is provided by Mestelman and Welland 1988, who study the effects of advance production on the relative performance
of posted offer and double auction markets. They find that advance production, which is essentially the same as capacity precommitment, leads to competitive outcomes under
both trading institutions. However, as noted by Holt Holt, 1995, p. 376, the design used by Mestelman and Welland does not distinguish well between competitive outcomes and
Cournot outcomes nor is that the purpose of their study.
The experiment described in this paper was designed to test whether the Kreps and Scheinkman results emerge in an experimental market organized according to the assump-
tions of that model. To achieve this end we have followed the assumptions of the Kreps and Scheinkman model closely. In particular, we have used efficient rationing, which is a crucial
assumption of the model, as demonstrated by Davison and Deneckere 1986 who show that under other rationing mechanisms, e.g. proportional rationing, the Kreps and Scheinkman
result may not emerge.
Since the Kreps and Scheinkman model combines the two opposites of quantity-setting and price-setting, it is also interesting to compare the experimental performance of the model
with those of the Cournot and Bertrand models. This is done using the Fouraker and Siegel 1963 results for the two market forms. After the presentation of Fouraker and Siegel’s
results in Section 2, there follows a description of the experimental formulation and the set-up of the experimental sessions in Section 3. Section 4 derives equilibrium predictions.
Section 5 analyzes the outcome of the experiment and Section 6 concludes.
2. Fouraker and Siegel’s oligopoly markets
