The comparative statics of a competitive industry with free entry and uncertainty

Abstract

This paper analyzes a competitive industry with free entry and uncertainty. By using a two-stage decision model instead of a conventional one-stage (or simultaneous) model, we conduct the comparative statics of the industry when either demand or factor-price uncertainty exists. We find that increased uncertainty will induce risk-neutral firms to enter the industry and to decrease output ex post. Thus, even under risk neutrality both the entry or exit behavior of firms and output choice are effected by uncertainty unlike the case of the one-stage model. It is shown that the effects of changes in demand and factor-price on the number of firms in the industry and firm's output are the same for both cases with demand and factor-price uncertainty, and moreover are unaffected by the firms' attitude toward risk.