Free Entry and Social Inefficiency

TLDR

The paper aims to characterize when free‑entry equilibrium yields too many, too few, or the optimal number of firms. The authors compare the actual entrant count under free entry to the planner‑optimal count, treating post‑entry firm behavior as given and solving a second‑best welfare maximization. They show that entry bias conditions can be expressed solely via the post‑entry game outcome, obviating the need to model that game explicitly.

Abstract

Our goal is to provide a simple, yet general, exposition of the conditions under which the number of entrants in a free-entry equilibrium is excessive, insufficient, or optimal. Our analysis compares the number of firms that enter a market when there is free entry with the number that would be desired by a social planner who is unable to control the behavior of firms once they are in the market. That is, we consider the second-best problem of choosing the welfare-maximizing number of firms, while we take as given their noncompetitive behavior after entry. We demonstrate that the crucial conditions for establishing the presence of an entry bias can be stated quite simply in terms of the outcome of the postentry game played by entrants. In contrast to previous work, we do not need to model this postentry game explicitly.