Dynamic Bertrand-Edgeworth Competition with Uncertain Demand and Entry

In this paper we investigate a two-period Bertrand-Edgeworth oligopoly model in which two capacity-constrained rms (incumbents) compete facing future demand uncertainty as well as uncertainty about entry. These rms must choose between pricing low and secure sales in the first period or, alternatively, pricing high in the first period to sell later when their non-contestable demand - i.e., the demand which their capacity constrained rival cannot contest - may be greater. We find that, when each incumbent is able to meet all demand needs, firms randomize in the second period and set deterministic prices in the first period. We then show that the expected market price across both periods reacts relatively more to changes in the likelihood of entry than in the probability of positive future demand. We conclude by exploring the implications of our model for merger control and determine how demand- and supply-side uncertainty affects the compensating marginal cost reductions required for prices not to rise after a merger.