Sunk Costs, Contestability, and the Latent Contract Market

The idea that an industry with sunk costs may be contestable even in the absence of long-term contracts has received little attention informal economic theory yet is sometimes popular among practitioners. This paper formally illustrates the argument. In an infinitely repeated game, there exists a class of contestable outcomes in which the monopolist sells only on the spot market and charges low prices along the equilibrium path to prevent customers from resorting to long-term contracts. The crucial test for contestability is the level of transaction costs in the latent contract market.     

Import Protection, Export Promotion, and Product Positioning

The argument that import protection may lead to export promotion is examined from the marketing standpoint. The model shows that protection allows home firms to cover a larger portion of the domestic market than they otherwise would and to target market segments that are closer to the mainstream. At the same time, foreign competitors are forced to retreat to more idiosyncratic market segments of narrower appeal. Thus, protection gives home firms a product positioning advantage over their foreign rivals; this advantage translates into higher market share and profits—not only in the protected home market, but also in export markets.     

Self-Regulation,Innovation, and the Financial Industry

The paper shows that the presence of continuous innovation may be one of the driving forces of self-regulation. In an infinitely repeated game, there exists a class of subgame perfect equilibria in which the self-regulatory organization, or SRO, pursues socially desirable objectives along the equilibrium path to stave off government intervention. Delegating regulatory authority to the SRO eliminates certification-related delays in the adoption of new services, fosters innovation and leads to higher social welfare.     

Downstream Vertical Foreclosure and Upstream Innovation

I examine a link between downstream foreclosure and upstream innovation. The crucial ingredient of the model is the presence of dynamic economies of scale upstream in the form of competition in R&D. The reason an upstream supplier has a captive buyer is to force rival suppliers to incur the disadvantages of low-scale production and discourage them from innovating. The downstream buyer is offered favorable terms and is “convinced” to sign an exclusive supply contract and accept captivity. In this context, downstream foreclosure may reduce consumer welfare.     

The Effects of Integration on R&D Incentives in Systems Markets

We consider a systems market where two complementary components must be used in combination to provide valuable services. The market for the first component is monopolized whereas the market for the second is potentially served by multiple firms. We show that integration of the monopolist into the competitive complementary market may distort incentives for R&D, reducing total economic welfare.