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Matilda Orth
Research Institute of Industrial Economics (IFN), Stockholm
matilda.orth@hhs.se
April 9, 2018
Homogeneous products
Inverse demand function: P(q), where q is industry output
Number of firms: n
Fixed set-up cost: e > 0
Identical costs: C (qi )
Symmetric equilibrium:
◮ All firms produce the same quantity q(n) (depends on the number of
firms) The quantity each firm will produce depends on the total number of firms.
Two stages
◮ Stage 1: firms decide whether to enter or not
◮ Stage 2: firms engage in quantity competition (Cournot)
Assumptions
1 Output per firm q(n) decreases with n such that q(n + 1) < q(n)
Business stealing
∂(q(n))
∂n <0
2 Industry output q increases with n
∂(nq(n))
∂n >0
3 Price above marginal cost for all n
P∗ > C ′ ∀ n
Z nq(n)
W (n) = P(s)ds − nC (q(n)) − ne
0
Because
∂q(n)
1
∂n <0
2 P > C ′ ∀n
∗
Heterogeneous firms
◮ Less clear relationship between free/social optimal entry and welfare
Trade-off
◮ How consumers value different firms/products
◮ Degree of business stealing + duplication of costs
Assessment:
◮ supply of stores/products
◮ market shares, accessibility
◮ traffic and public transport
◮ environmental issues
◮ ...
Government intervention
◮ Reduce competition, higher prices, lower quantities, less product
variety, lower employment,...
Construct variables
◮ NEmt = no. of stores that enter market m between year t − 1 and t
◮ NSmt = total no. of stores in market m in year t, including stores that
enter market m between year t − 1 and t
◮ NXmt−1 = no. of stores that exit market m between year t − 1 and t
Period Correlation
1963-1967 0.18
1967-1972 0.45
1972-1977 0.36
1977-1982 0.24
250
200
150
100
50
.08
.06
.04
.02
0
Entry rates can be high but entrants rarely have large market shares
GEOGRAPHIC COORDNATES
PRICE
PRODUCT RANGE REGULATION
What would be the outcome for consumers, firms and society under
an alternative public policy?
◮ Without subsidy, new subsidy design, taxes, pricing, product mix,
tariffs, regulations, new markets,...
◮ Not trivial to provide an accurate answer! Highly relevant to policy
makers, firms, consumers and society!
Road-map
◮ Estimate the model, interpret, cross-check with observed data
◮ Impose a policy change (parameter of the model): re-solve the model
under alternative public policy
◮ Varies by research question: e.g., prices, quality, market shares,
markups, profits, entry/exit,...
Randomized experiment?
Potential entrants
◮ Enter or to stay out
◮ Draw of entry cost κ ∼ G κ
◮ Entry draws are i.i.d across markets and time
◮ Observe their own draw, not rivals but distribution is known to all
◮ Start to operate next year
pexit (s; θ) = Pr (λ > VC (s; θ)) = 1 − G (VC (s; θ)), where G (·) is the
cumulative distribution function
Empirical implementation:
◮ Static per-period profits, value of continuing, value of entering
◮ Operating profits, observed entry and exit decisions
◮ State variables: s = (n, z)
◮ Distributional assumptions on fixed costs and sunk costs
Data:
◮ Dentist and chiropractors in the US
◮ Five-year panel 1982-2002
◮ 400 local markets
◮ ”Panel version of Bresnahan and Reiss”
Results
◮ (1) Source of competitive pressure: combination of direct effect of n on
toughness of competition, entry costs and fixed costs
◮ (2) As n increases: prob(exit) rises, prob(entry) falls
2001 2002 2003 2004 2005 2006 2007 2008 2001 2002 2003 2004 2005 2006 2007 2008 2001 2002 2003 2004 2005 2006 2007 2008
Bergendahls Others
1,500
1,000
500
0
2001 2002 2003 2004 2005 2006 2007 2008 2001 2002 2003 2004 2005 2006 2007 2008