Stackelberg Equilibrium with Private Information

Abstract

There are industries in which not every firm is on an equal footing. Some firms play a dominant role, while others, following the lead of the dominant firms, act rather passively. There are two common approaches to incorporate these passive firms in theoretical analysis. In the dominant firm framework, passive firms are modeled as competitive fringe firms which take market prices as given, and do not recognize the impact of their production decisions on the market price and thus the output decisions of dominant firms. In the Stackelberg leader-follower framework, passive firms are modelled as followers which take the dominant firms’(leaders) output decisions as given, although the followers are fully aware of the impact of their production decisions on the leaders’ output decisions. In both approaches, dominant firms are envisioned as those who not only recognize that their production decisions affect market prices and hence other firms’ output decisions but also take full advantage of the passiveness of competitive fringe firms or followers. The choice of approach may well depend on the type of industry one is interested in investigating. For example, if the industry is highly concentrated, the Stackelberg approach may be considered better suited than the other.