Review of Industrial Organization
13: 409–423, 1998.
1998 Kluwer Academic Publishers. Printed in the Netherlands.
Investment under Demand Uncertainty, Ex-Ante
Pricing, and Oligopoly
CIARAN DRIVER and FABRICE GOFFINET
Imperial College Management School, University of London, U.K.
Abstract. This paper considers the capacity choice of duopolists who set price ex-ante under demand
uncertainty with risk-neutrality. The duopolists compete for market shares on the basis of availability
of supply, rather than by price competition. Collusive pricing coexists with Cournot–Nash capacity
choice. A formal model is presented, where the market share of each ﬁrm may deviate from the
certainty share due to rationing. With shares reﬂecting different costs, capacity utilisation for the
lower cost ﬁrm is expected to be substantially lower. The implications for the price-cost margin and
capacity formation are also explored.
Key words: Investment, capacity, risk, duopoly, utilization, price.
“Each oligopolist is well aware that as demand moves
ahead he can increase his relative share of the mar-
ket and his proﬁts by expanding at a rate above that
at which capacity as a whole should be extended to
maximise the joint proﬁts of all, provided any other
lags behind the best rate for the industry. And
conversely each knows that if he fails to keep up with
the best rate, others, by exceeding it, can gain what he
might have had.” Donald Wallace (1937, p. 338)
Oligopoly and uncertainty are both facts of life: yet they make for immense prob-
lems in modelling economic activity such as investment. To date, these questions
have largely been addressed separately to the exclusion of possible interactions.
For example, a standard oligopoly reference text (Tirole 1988) contains just three
references to uncertainty, while much of the literature on uncertainty is conﬁned to
models of monopoly or perfect competition. (See Driver and Moreton 1992 for a
We are grateful to Peter Lambert for suggesting this line of enquiry and for perceptive com-
ments. Emmanuel van Rillaen and Panos Kanavos provided mathematical assistance, but any errors
are ours. We would also like to thank the Nufﬁeld Foundation and the ESRC (R000232176) for
ﬁnancial support. Fabrice Gofﬁnet was funded by the ERASMUS programme. Thanks also to two
referees, to Jean-Bernard Chatelain and to participants of the seminar at the Economics Department,
Universite Catholique de Louvain; also the Economics Faculty, ANU, Canberra, at which the paper
was presented, and RSSS, ANU where the paper was completed.