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Figure 4: Illustration of the Solutions: Industry investment X(c) and critical demand realizations θc for the 4 scenarios analyzed.

below the perfectly competitive outcome All second best solutions lie between these two solutions (proportionally according to λ). This is illustrated in figure 4.

The solution under imperfect competition turns out to be qualitatively different.

The

reason is that strategic firms take into account that their rivals will reduce their spot market production at the second stage in case they invest more heavily in low marginal cost technologies at the first stage. As a result, the locus of the critical demand realizations θ c E Q a l w a y s l i e s a b o v e t h e c o r r e s p o n d i n g l o c u s o f t h e c r i t i c a l d e m a n d r e a l i z a t i o n s i n t h e fi best solution as illustrated in figure 4. In other words, for any given technology c0, this technology will start to be operating at a lower demand realization in the First Best and the monopoly case (and all intermediate “second best” solutions) than in the case of imperfect r s t

c o m p e t i t i o n ( f o r m a l l y : θ c F B

< θ c E Q

for all c [c, c]). This strategic effect is irrelevant,

however, when either (i) production is zero (for c c), or (ii) firms are capacity constrained and do not react to modified cost functions of the rivals (i.e. for c c). In both cases the

c r i t i c a l d e m a n d r e a l i z a t i o n s c o i n c i d e ( i . e . θ c F B

= θ c E Q

for c = {c, c}), for an illustration

a g a i n s e e fi g u r e 4 . A l s o f o r t h e c a s e o f s t r a t e g i c fi r m s , I n d u s t r y i n v e s t m e n t X E Q

(c) relate to

t h e c r i t i c a l d e m a n d r e a l i z a t i o n s θ spot market competition23. c E Q

by the standard equilibrium conditions of the Cournot

2 3 I t i s w e l l k n o w n , t h o s e a r e g i v e n b y : P ( X E Q

( c ) , θ c E Q

) + P q ( X E Q

( c ) ) 1 n X E Q

(c) = c c.

21

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