free entry AND social inefficiency

The RAND Corporation

Free Entry and Social InefficiencyAuthor(s): N. Gregory Mankiw and Michael D. WhinstonReviewed work(s):Source: The RAND Journal of Economics, Vol. 17, No. 1 (Spring, 1986), pp. 48-58

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Rand Journal of Economics Vol. 17, No. 1, Spring 1986

Free entry and social inefficiencyN. Gregory Mankiw* and Michael D. Whinston**

Previous articles have noted the possibility of socially inefficient levels of entry in markets in whichfirms must incurfixed set-up costs upon entry. This article identifies thefundamental and intuitiveforces that lie behind these entry biases. If an entrant causes incumbentfirms to reduce output, entry is more desirable to the entrant than it is to society. There is therefore a tendency toward excessive entry in homogeneous product markets. The roles of product persity and the integer constraint on the number offirms are also examined. 1. Introduction * Economists typically presume that free entry is desirable for social efficiency. As several articles have shown, however, when firms must incur fixed set-up costs upon entry, the number of firms entering a market need not equal the socially desirable number. Spence (1976a) and Dixit and Stiglitz (1977), for example, demonstrate that in a monopolistically competitive market, free entry can result in too little entry relative to the social optimum.In more recent work von Weizsacker (1980) and Perry (1984) point to a tendency for excessive entry in homogeneous product markets. Nevertheless, despite these findings, many economists continue to hold the presumption that free entry is desirable, in part, it seems, because the fundamental economic forces underlying these various entry biases remain somewhat mysterious. Our goal is to provide a simple, yet general, exposition of the conditions under which

the number of entrants in a free-entry equilibrium is excessive, insufficient, or optimal. Ouranalysis compares the number of firms that enter a market when there is free entry with the number that would be desired by a social planner who is unable to control the behavior of firms once they are in the market. That is, we consider the second-best problem of

choosing the welfare-maximizing number of firms, while we take as given their noncompetitive behavior after entry. We demonstrate that the crucial conditions for establishing the presence of an entry bias can be stated quite simply in terms of the outcome of the postentry game played by entrants. In contrast to previous work, we do not need to model this postentry game explicitly.

* Harvard University and National Bureau of Economic Research.

** Harvard University. We would like to thank FranklinFisher,Alvin Klevorick,Andreu Mas-Colell,John Riley, RichardSchmalensee, Lawrence Summers, and two referees for helpful comments on earlier drafts of this article. 48

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This approach has two advantages. First, it uncovers the fundamental and intuitive reasons behind the presence of entry biases. Second, it provides a set of propertiesthat can be readily checked for any particular application. We focus extensively on the central roles played by two aspects of the postentry game in producing an entry bias: imperfect competition and what we call the"business-stealing effect." The business-stealingeffect exists when the equilibrium strategicresponse of existing firms to new entry results in their having a lower volume of sales-that is, when a new entrant"steals business" from incumbent firms. Put differently, a business-stealing effect is present if the equilibrium output per firm declines as the number of firms grows. Intuitively, it would seem that most markets would be characterized by such an effect.' As we shall demonstrate, in the presence of imperfect competition (so that firms do not act as pricetakers after entry), the business-stealing effect is a critical determinant of the direction of entry bias. After formally specifying our model in Section 2, we begin our analysis in Section 3 by consideringa homogeneous product market. Ignoringthe integerconstrainton the number of firms (as has been done in most of the previous literature), we demonstrate that if the postentry price exceeds marginal cost and if a business-stealing effect exists, then free entry leads to excessive entry from a social standpoint (Proposition 1). Intuitively, business stealing by a marginal entrant drives a wedge between the entrant's evaluation of the desirability of his entry and the planner's: the marginal entrant's contribution to social surplus is (except for second-order effects) equal to his profits less the social value of the output lost owing to the output restriction he engenders in other firms. The business-stealing effect therefore makes entry more attractive than is socially warranted.2 We show by example that the resulting bias can, in fact, be dramatic: the equilibrium number of firms can exceed the socially optimal number by a very large margin. We then consider the role of the integer constrainton the number of firms. In Proposition 2 we prove the fully rigorous result: Under the conditions described above, the free-entry number…… 此处隐藏：33865字，全部文档内容请下载后查看。喜欢就下载吧 ……