In declining industries, capacity must be reduced in order to restore profitability. Who bears this burden? Where production is all or nothing, there is a unique subgame-perfect equilibrium: the largest firms exit first (P. Ghemawat and B. Nalebuff [1985]). In this paper, firms continuously adjust capacity. Again, there is a unique subgame-perfect equilibrium. All else equal, large firms reduce capacity first and continue to do so until they shrink to the size of their formerly smaller rivals. Intuitively, bigger firms have lower marginal revenue and correspondingly greater incentives to reduce capacity. This prediction is supported by empirical findings.

Keywords:

• Market Structure: Industrial Organization and Corporate Strategy
• Economic Capacity
• Microeconomics--Theory of Firm and Industry under Imperfectly Competitive Market Structures