Excess Capacity, Entry, and Market Structure in the Chemical Processing Industries

1985| Working Paper No. 830

Recent advances in oligolpoly theory suggest a number of reasons why excess capacity may be related to entry and market structure. This paper used commprehensive data on 40 chemical products to test a series of hypotheses on the determinants of excess capacity. The results suggest that excess capacity resulting form preemptive rivalry was most prevalent for products with (1) intermediate seller concentration, and (2) “strategically heterogeneous” producers. Although it is difficult to distinguish the amount of excess capacity held by incumbents as an entry deterrent, the post-entry response of incumbents is analyzed in detail. The results document an aggressive response of incumbents following entry in concentrated markets, particularly when incumbents were homogeneous. On average in such markets, new entry triggered significant (and relatively persistent) excess capacity, substantial price cutting, and continued expansion by incumbent firms.