Sylos’s model has been severely attacked on several grounds. The criticisms launched against his theory may be classified in two groups: weaknesses due to unrealistic assumptions; and weaknesses due to assumptions which, even if relaxed, do not affect the validity of the model.
The second group comprises the following criticisms.
Firstly, Sylos has adopted a methodologically naive approach, based on numerical examples.
Secondly, he has assumed a very rigid technology, with strong discontinuities.
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Thirdly, he has used a definition of unitary elasticity which is rather confusing. These criticisms, correct as they are, do not impair the basic model. In sections II and III below we will see how Modigliani and Bhagwati relaxed these assumptions and generalized Sylos’s model, also giving it a rigorous appearance.
The first group of criticisms concentrates on the plausibility of Sylos’s Postulate. It has been argued that the strategy of keeping the pre-entry quantity constant is not the best alternative action open to the established firms
The Sylos strategy implies a defensive attitude the existing firms practically give up their initiative in price-setting, since the price will be determined by the quantity which the entrant decides to sell in the market. It may be preferable for the existing firms to retain their control on the price and adopt other actions; for example, increase their pre-entry output.
This ‘retaliation strategy’ will lead to a reduction in price, possibly below the LAC of all firms. Depending, however, on their financial reserves and the length of the time period over which established firms expect the price to remain below their LAC, they may find it profitable in the long run to start a price war and eliminate the entrant. Such elimination tactics have been successfully adopted in several cases. This strategy is particularly attractive since it will serve as a lesson to future potential entrants.
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The ‘mixed strategy’ of partly reducing the pre-entry output and partly allowing the price to fall post-entry seems to have several advantages: some excess profits will still be earned, while the established firms can start an intensive non-price competition which may both eliminate the entrant and discourage further entry. Bain and others have argued that the ‘mixed strategy’ is the more realistic and more likely in the real world.
Other serious shortcomings of Sylos’s model are the following:
Firstly, the scale- barriers are not important if the entrant is an already-established firm in the same or in another industry (within-entry and cross-entry). Even for completely new firms economies of scale have not been found to be important barriers in practice.
Secondly, scale economies may in fact enhance entry if the limit price is very high; a firm may decide to enter despite the initial losses, if the current price yields lucrative profits to the large-scale plants.
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Thirdly, scale-barriers may be offset by the advantages of a new firm, which can adopt the most up-to-date methods of production and choose its location optimally, given the supply and demand conditions in the market.
Fourthly, the rationale of an entry-preventing policy is not given; neither does Sylos discuss explicitly the assumed preference of firms, existing and potential, for the behavioural pattern implied by the Sylos’s Postulate.
Fifthly, the model is static; it does not examine the long-run implications of the adoption of an entry-preventing policy. As Pashigian has suggested, the rational firm should examine the profitability of all the alternatives open to it. Pashigian argues that in most cases it may be more profitable to charge the monopoly price for a certain (initial) period of time and subsequently charge a limit price or a purely competitive price, depending on the profitability of each alternative strategy (see section IV below). Such an analysis is dynamic, since it involves the examination of the time paths of alternative strategies.
Sixthly, the model assumes considerable knowledge of the conditions of supply and demand: the price leader is assumed to know the cost structure of all plant sizes, to have estimated accurately the market demand, and to know the minimum (normal) acceptable profit of the industry. The required amount of information is very unlikely to be available in practice.
In general Sylos’s contribution lies in the systematic discussion of the most important determinants of the limit price in the case of substantial economies of scale. These factors provided the basic material used by Modigliani and Bhagwati in the development of more general and more rigorous models of limit-pricing.