Excessive vs. insufficient entry in spatial models: When product design and market size matter

Abstract

Under spatial product differentiation and product design, we identify conditions for either excessive or insufficient firm entry. We extend previous settings, based on the Salop circular model, to analyze the combined role of positive demand elasticity and endogenous targeted product design. First, we show that, given the number of firms, the equilibrium level of targeted design is either excessive or insufficient, depending on demand elasticity. Second, with free entry, we show that the degree of targeted product design increases with the relative market size and decreases with demand elasticity. Based on these effects, the interplay between demand elasticity and market size yields novel welfare results. In particular, we show that excessive entry always occurs for small demand elasticities but, for large demand elasticities, market size matters: entry is insufficient in small and large market sizes, but it is excessive in intermediate market sizes.