Sophisticated Entry in a Model of Spatial Competition

TLDR

The authors aim to analyze free‑entry equilibrium in a spatial competition model. The model assumes fixed incumbent locations and rational profit expectations by entrants. Large economies exhibit that with U‑shaped costs, free‑entry equilibrium is unique, socially optimal, and zero‑profit, whereas without diseconomies of scale, equilibrium is imperfect, non‑unique, and firms can earn substantial pure profit.

Abstract

We analyze free-entry equilibrium in a model of spatial competition in which locations of established firms are fixed and entrants' profit expectations are rational. Our most interesting results concern large economies -- economies in which the number of firms is arbitrarily large. When the average cost function is U-shaped, free-entry equilibrium is unique, socially optimal, and characterized by zero profit. In contract, when there are no diseconomies of scale, even large economies are stubbornly imperfect. Firms can earn substantial pure profit and free-entry equilibrium is neither unique nor socially optimal.