Entry and Welfare An Illustrated, Selective Survey - World Bank

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Entry and Welfare An Illustrated, Selective Survey - World Bank

Entry and WelfareAn Illustrated, Selective SurveyLuís CabralNew York UniversityWorkshop onEntry, Entrepreneurship, and Financial DevelopmentWorld Bank, January 10–11, 2005.


Outline• Distortions in competitive industries• Barriers to entry in industries with market power• Applications


Outline• Distortions in competitive industries• Barriers to entry in industries with market power• Applications


Outline• Distortions in competitive industries• Barriers to entry in industries with market power• Applications


Competitive industries• Perfect competition: price taking, free entry,identical cost structures• Fundamental theorem: efficiency• Empirical evidence: large intra-industry variations inproductivity• But third condition is not necessary


Welfare cost of distortions• Traditional analysis: Harberger triangle- Harberger: allocative inefficiency very small- Hall: maybe not so small• Dynamic analysis: lower turnover, lower welfare• My point No. 1: It’s not just the size of distortions,also how they vary across firms


Welfare cost of distortions• Traditional analysis: Harberger triangle• Dynamic analysis: lower turnover, lower welfare- Hopenhayn and Rogerson: very large cost- Olley and Pakes: productivity improvement by reallocation- Chun et al: turnover and productivity growth• My point No. 1: It’s not just the size of distortions,also how they vary across firms


Welfare cost of distortions• Traditional analysis: Harberger triangle• Dynamic analysis: lower turnover, lower welfare• My point No. 1: It’s not just the size of distortions,also how they vary across firms- Also, productive inefficiency is orders of magnitude greaterthan allocative inefficiency


Numerical simulation• Industry with 1000 firms, each with capacity 1.• c i ∼ N(100, 100); t i ∼ N(µ, σ)• Linear demand: p = 200 − .1Q• Allocative inefficiency: µ > 0 when σ = 0• Productive inefficiency: σ > 0


Numerical simulation• Industry with 1000 firms, each with capacity 1.• c i ∼ N(100, 100); t i ∼ N(µ, σ)• Linear demand: p = 200 − .1Q• Allocative inefficiency: µ > 0 when σ = 0• Productive inefficiency: σ > 0


10%.Welfare variation (%).5%.µ = 50..0%. ..µ = 25µ = 5.0 25 50.σ


Outline• Distortions in competitive industries• Barriers to entry in industries with market power• Applications


Industries with market power• Business stealing and excess entry• Surplus generation and insufficient entry• Numerical simulation


Industries with market power• Business stealing and excess entry• Surplus generation and insufficient entry• Numerical simulation


Industries with market power• Business stealing and excess entry• Surplus generation and insufficient entry• Numerical simulation- Linear demand, zero marginal cost, entry cost = 20%monopoly profits- Toughness of price competition: p(n) = 1/(1 + n ρ )- Compare equilibrium to second-best social optimum


1Ŵ/W ∗̂n, n ∗....1..10.8.Ŵ/W ∗..8.6..6.4.2.... . .. . . . .. ... .. . . ... . . ... . . . . . . . . . . ... . . . .n ∗̂n...42..1 2 3 4Figure 6: Equilibrium and socially optimal entry as a function of toughness ofcompetition (linear demand, zero variable costs, entry cost 10% of monopolyprofit).......ρlinear demand and constant marginal cost. Suppose moreover that toughnessof product market competition can be characterized by a parameter ρ.Specifically, let market price be given by


Outline• Distortions in competitive industries• Barriers to entry in industries with market power• Applications


Application: Portugal• The McKinsey report• Entry into banking


Application: Portugal• The McKinsey report• Entry into banking

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