Entry deterrence and signaling in a nonrenewable resource model

We analyze a nonrenewable resource model in which an incumbent firm faces potential entry from a rival firm. The incumbent has private information about its stock size but the rival can observe extraction. With observable extraction and unobservable stock, the rival can use extraction as a signal about stock, from which it can infer whether entry is likely to be profitable. We characterize the necessary conditions for pooling and separating perfect Bayesian equilibria in a signaling game of resource extraction and provide examples of each. We show that the incumbent will often prefer pooling to separating even though welfare is higher in separating equilibrium.