ENTRY REGULATION Free entry and welfare Suppose number of - - PowerPoint PPT Presentation

ENTRY REGULATION

Free entry and welfare

• Suppose number of (identical) firms increases from n to n + 1
• Price drops from pn to pn+1

Total output increases from n qn to (n + 1) qn+1

• Impact of entry in social welfare

− Consumer surplus increases by approx 1

2(pn − pn+1)

• Qn+1 − Qn
• − Entrant gains πn+1 − E

− Incumbent firms lose n (πn+1 − πn)

• Presumably, if entry takes place, then πn+1 − E > 0

What about social welfare?

Free entry and welfare

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

pn+1 pn n qn+1 n qn (n + 1) qn+1 p q D MC A B

C Marginal entrant’s variable profit: A + B. Increase in total surplus: B + C.

Free entry and welfare

• Business stealing effect: part of the entrant’s variable profit (area

A) is a transfer from incumbents

• Negative entry externality: A is a gain for entrant but not a gain

for society as a whole

• Consumer surplus effect: entry implies an increase in consumer

surplus (area C) that is not captured by firms

• Positive entry externality: C is a gain for society as a whole gain

but not for entrant

• If A > C, free entry ⇒ excess entry

If A < C, free entry ⇒ insufficient entry

Free entry and welfare

• Product differentiation unimportant, competition soft:

business-stealing effect dominates, free-entry ⇒ excessive entry

• Product differentiation very important, competition very fierce:

consumer surplus effect dominates, free entry ⇒ insufficient entry

• Examples

− banking − radio stations − real estate brokerage

Example: US radio stations

• Radio stations make money from advertising
• Important entry decision: location in product space
• Entry externalities:

− entertainment offered to listeners beyond cost of listening to ads − stealing listeners from similar stations

• Free entry result in too many rock stations, two few

classical music stations

• Relative so social optimum, loss to firms and

advertisers is 45% of revenue

Firm turnover and allocative efficiency

• Above analysis assumes identical firms and focuses on allocative

efficiency (how much to produce)

• If different firms have different costs, selecting the lowest cost

firms improves productive efficiency (lower total costs)

• Additional benefit from entry and exit: selection and asset

reallocation

− Lower cost firms enter, higher cost firms exit (extensive margin) − Among incumbents, lower cost firms have higher output (intensive margin)

Example: telecom equipment industry

• Deregulation of US telecommunications equipment

industry implied significant turnover

− Entry and exit − Capital reallocation from low productivity to high-productivity firms

• One way to measure overall effect is to compute

correlation between productivity and output

• Additional benefit from entry and exit: selection and

asset reallocation

− High correlation: capital concentrated on higher productivity firms − Low (maybe negative) correlation: capital not concentrated on higher productivity firms

Deregulation, turnover and productivity

75 80 85 −0.15 −0.10 −0.05 0.00 0.05 0.10 0.15 Correlation (output,productivity) Year

Correlation between output and productivity increases as deregulation progresses

Regulation to encourage entry

• Orphan drugs: developed specifically to treat a rare

medical condition (orphan disease)

• Examples: glioma, multiple myeloma, cystic fibrosis,

phenylketonuria, snake venom poisoning, and idiopathic thrombocytopenic purpura

• Easier to gain marketing approval; financial incentives

(e.g., extended exclusivity periods)

• Currently more than 400 orphan designated drugs in

clinical trial process in US and EU

• Generally acknowledged as a successful policy measure.

In US, number of orphan drugs increased from 38 in 1983 (Orphan Drug Act) to 1,129 in 2004

Related problem: poor countries’ diseases (malaria, ebola?)

Regulation to discourage entry

• Suppose that p = ¯

p, no product differentiation, free

• entry. Then consumer surplus effect is zero, whereas

business stealing effect is positive: excess entry

• Example: banks and branches. Regulated interest rates

and/or tacit collusion imply p = ¯ p > c

• Portugal in 1980s: entry deregulation precedes interest

rate deregulation

• Huge concentration bank branches is urban areas
• Partial solution: entry fees for new branches

Entry regulation as capture

• Real estate brokerage

− In 2001, US Treasury and Fed propose that banks be allowed as real estate brokers − National Realtors Association lobbies against − In 2009, Obama signs Act that permanently bars banks from real estate brokerage

• Pharmacies

− In 2009, EU court ruled that pharmacy ownership restrictions are OK − German legislation frustrate multinational chains − Many other countries (e.g., Australia) have similar restrictions

NYC taxi cabs

100 200 300 400 500 600 700 1950 1969 1970 1980 1990 2000 2010 Number of medallions issued Medallion price $ 000 Year 6 8 10 12 14

New York taxi medallions

• What determines the price of NYC taxi medallions, in

particular, what factors lie behind the recent increase?

• What do you think will happen to medallion prices in

the near future?

• What determines the number of medallions issued by

the city?

• What policy changes (if any) would you recommend

Mayor Bloomberg?

Alternative investments; E/P ratio

Entry regulation as capture (cont)

• Uber

− Mobile-phone app to link passengers and car drivers − Brussels, Seattle and Miami have banned / limited − New York’s Attorney General objects to practice of pricing more when demand is heavy

• Airbnb

− Online service that lets users easily rent homes or apartments for short-term stays − Hotel industry is lobbying hard to kill the upstart

Regulation in the Internet era

What has made the Internet revolutionary is that it’s

• permissionless. No one had to get approval from

Washington or city hall to offer Google searches, Facebook profiles or Apple apps. Adam Thierer, author of Permissionless Innovation The only question is how long it will take for these cyber cowboys to realize that working with the sheriffs is both good business and the right thing to do. New York Attorney General Eric Schneiderman