Entry Barriers and Economic Welfare

Abstract

The relationship between economic welfare and the number of firms in quasi-Cournot market is examined. In the first place, we presuppose the existence of strong (first-best) government that can enforce the marginal-cost principle to the firms along with regulating the number of firms. It is shown that there exist excessive number of firms at the free-entry quasiCournot equilibrium vis-a-vis the first-best welfare maximizing number of firms. The thrust of this result essentially survives even if we replace utopian first-best government by secondbest government that leaves the firms to pursue their respective profit maximization freely and engages solely in regulating the number of firms. It can be shown that the entry prevails again in this second-best world. Recent studies in the theoretical industrial organization literature have uncovered several instances which cast serious doubt on the reasonableness of a widespread belief that increasing competition will increase welfare (Stiglitz (1981), p. 184).' It has been shown that there are cases, which are not altogether unreasonable, where social welfare will be increased by strengthening, rather than weakening, the protection of incumbent firms from the threat of potential entry. This is in sharp contrast with the traditional belief.2 What is not known, however, is how robust these pathologies in fact are. We intend to settle this problem by proving two excess entry theorems in the quasi-Cournot (parametric conjectural variations) homogeneous oligopoly model (Seade (1980a, b)). In the first place, we presuppose the existence of strong (first-best) government that could costlessly enforce the marginal-cost pricing principle by firms in an oligopolistic market and regulate entry in pursuit of first-best social welfare optimization. It is shown that the number of firms at the free-entry equilibrium exceeds the first-best welfare optimizing number of firms. The result has already been noted by von Weizsacker (1980a, b) and others in terms of numerical examples. Our Theorem 1 asserts that this phenomenon always holds true for the family of quasi-Cournot models at hand. An implication of this result is that the existence of entry barriers which protect incumbent firms from potential competitors is not necessarily welfare decreasing in sharp contrast with the traditional belief. A problem remains with Theorem 1, however, in that an omnipotent first-best government does not exist in reality, and the first-best ideal is unrealizable in the actual economy. Therefore, even if the intervention by first-best government with view to restricting the number of firms within an industry may be welfare-improving, it does