Sunk Costs, Entry, and Exit in Dynamic Oligopoly

Abstract

This paper develops a dynamic econometric framework for the analysis of entry, exit, and competitive conduct in oligopolistic markets. This framework only requires panel data on the demand and producer counts of geographically dispersed markets over time. It is a dynamic extension of Bresnahan and Reiss's (1990, 1991) framework for the analysis of static competition in a cross-section of markets. Our extension to the infinite-horizon model facilitates the empirical analysis of the dynamic determinants of market structure and competition: sunk entry costs and uncertainty. Moreover, it is needed for the consistent measurement of static market primitives, such as the toughness of competition. Our model's timing and expectation assumptions help to select an essentially unique Markov-perfect equilibrium that can be computed quickly by solving a finite sequence of dynamic programming problems with low-dimensional state spaces. We apply our model to the empirical re-analysis of sunk costs and the toughness of competition in the US market for dental services, using Bresnahan and Reiss's (1993) panel data on the number of dentists across geographical markets in the US.