If the incumbent firm installs sufficient excess capacity, the potential entrant knows that equilibrium will involve a too high level of output by the incumbent firm

Question

Quizplus · Accepted Answer

The potential entrant can observe the excess capacity of the incumbent firm before entry and use it as a signal that the incumbent is prepared to produce a high level of output to deter entry. Once the entrant enters the market, the equilibrium level of output will be higher than what would have been produced if the incumbent had not installed excess capacity. Therefore, the potential entrant knows that equilibrium will involve a too high level of output by the incumbent firm after entry.

If the Incumbent Firm Installs Sufficient Excess Capacity, the Potential