Cost uncertainty in an oligopoly with endogenous entry

Marco De Pinto,Laszlo Goerke

doi:10.1111/boer.12326

Abstract

AbstractHow does cost uncertainty affect the welfare consequences of an oligopoly? To answer this question, we investigate a Cournot oligopoly in which firms produce a homogeneous commodity and market entry is feasible. Marginal costs are unknown ex ante, that is, prior to entering the market. They become public knowledge before output choices are made. We show that uncertainty induces additional entry in market equilibrium and also raises the socially optimal number of firms. Since the first change dominates, the excessive entry distortion is aggravated. This prediction is robust to various extensions of the analytical setup. Furthermore, the welfare loss due to oligopoly tends to increase with uncertainty.

Highlights

An increase in the number of competitors in an oligopolistic market generally reduces each firm’s output
Since the same is true with regard to the number of firms preferred by a social planner, a priori the impact of cost uncertainty on excessive entry, i.e., on the difference between the social planner’s choice and the market outcome, is ambiguous
We analyze how the endogenous variables change with cost uncertainty in market equilibrium and in social optimum and, more importantly, consider their relative variation

Summary

Introduction

An increase in the number of competitors in an oligopolistic market generally reduces each firm’s output. It is a well-established prediction that in the presence of such businessstealing effect, there will be excessive entry in a homogeneous Cournot oligopoly with economies of scale, relative to the number of firms a social planner would choose. While a different distribution of profits has no direct welfare consequences, the profit effect raises the potential entrant’s incentives to take up production. It dominates the welfare-enhancing impact of entry on consumer surplus, which firms do not take completely into account either. Since the same is true with regard to the number of firms preferred by a social planner, a priori the impact of cost uncertainty on excessive entry, i.e., on the difference between the social planner’s choice and the market outcome, is ambiguous

Results

Discussion

Conclusion