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Equilibrium Limit Pricing: The Effects of Private Information and Stochastic Demand

Steven A. Matthews
Leonard J. Mirman

Abstract

A model is constructed in which a potential entrant uses prices to make inferences about industry conditions. Stochastic demand shocks occur after the incumbent firm's action, so that prices reveal only statistical information about the incumbent's private information. The equilibrium differs from standard signalling equilibria in that it can be unique, it depends on prior beliefs, and it is rich in comparative statics. Conditions are obtained for entry threats to result in limit pricing, lower entry probabilities, and lower expected profits for potential entrants.