Holding Idle Capacity to Deter Entry

In his 1980 Economic Journal article, Dixit concluded that a firm would never hold idle capacity to deter entry. We show that his result depends crucially on the special assumption that products are “strategic substitutes”, so that in Nash equilibrium the firm must always contract output in response to entry. Relaxing this assumption allows us to confirm Spence’s original intuition that firms may hold unused excess capacity to deter entry.