Excessive Entry and Social Inefficiencies : A Policy Experiment on Dynamic Efficiency Gains

This study evaluates how different lengths of entry protection impact consumer and producer surplus. We formulate a dynamic oligopoly model in the tradition of Ericson and Pakes (1995) and allow entry costs to vary over time. Firms choose the optimal time to enter a market, and make output and exit decisions. Using a detailed dataset on quarterly firm-level information on the static random access memory industry from 1977 to 2003, we find that entry costs decline by more than 80% throughout the life cycle which corresponds to entry cost reductions of $30 million per quarter. We perform a policy experiment to evaluate if declining entry costs over time cause social inefficiencies such that firms enter too early and incur excessive entry costs. Our policy experiment considers a social planner who can control the entry protection length of an incumbent firm. Our results show that a longer lasting entry protection monotonically reduces consumer welfare. Interestingly, a longer entry protection increases producer surplus in the industry due to entry cost savings associated with the prevention of excessive entry. If entry protection becomes sufficiently long the increase in producer surplus from achieving entry cost savings are getting close to compensating the losses in consumer welfare which would result in a total welfare increase