Dynamic Models of Oligopoly

2. COMPETITION IN TANGIBLE VARIABLES

2a. Introduction to state-space games

This section illustrates the use of state-space games by sketching the work of Spence [93] and Fudenberg and Tirole [30] on the use of irreversible investment as a strategic weapon. Earlier papers by Spence [92] and Dixit [20, 21] should be acknowledged, but as these assumed once-and-for-all choices of capital levels they are less suited to our expository purposes (for comprehensive treatments of barriers to entry, see also Encaoua et al. [26], Geroski and Jacquemin [37], and Von Weizsäcker [99]). Also, as we will see, the assumption that the incumbent may not invest after entry has occurred is very restrictive.

Thus, consider a duopoly, with firms indexed by i = 1,2. ...