| By: |
Jaap H. Abbring (Vrije Universiteit Amsterdam);
Jeffrey R. Campbell (Federal Reserve Bank of Chicago, and NBER) |
| Abstract: |
This paper considers the effects of raising the cost of entry for a potential
competitor on infinite-horizon Markov-perfect duopoly dynamics with ongoing
demand uncertainty. All entrants serving the model industry incur sunk costs,
and exit avoids future fixed costs. We focus on the unique equilibrium with
last-in first-out expectations: A firm never exits leaving behind an active
younger rival. We prove that raising a second producer's sunk entry cost in an
industry that supports at most two firms reduces the probability of having a
duopoly but increases the probability that some firm will serve the industry.
Numerical experiments indicate that a barrier to entry's quantitative
relevance depends on demand shocks' serial correlation. If they are not very
persistent, the direct entry-deterring effect of a barrier to a second firm's
entry greatly reduces the average number of active firms. The indirect
entry-encouraging effect does little to offset this. With highly persistent
demand shocks, the direct effect is small and the barrier to entry has no
substantial effect on the number of competitors. This confirms Carlton's
(2004) assertion that the effects of a barrier depend crucially on industry
dynamics that two-stage "short run/long run" models capture poorly. |
| Keywords: |
LIFO; FIFO; Sunk costs; Markov-perfect equilibrium; Competition policy |
| JEL: |
L13 L41 |
| Date: |
2007–04–27 |
| URL: |
http://d.repec.org/n?u=RePEc:dgr:uvatin:20070037&r=ind |