Promoting Lies Through Regulation: Deterrence Impacts of Flexible Versus Inflexible Policy

Abstract:     
This paper investigates an entry-deterrence model where a potential entrant, uninformed about the incumbent firm's production costs, observes two signals: the incumbent's output decision and the emission fee set by an informed regulator. We study contexts in which emission fees are flexible and inflexible across time. We show that not only an informative equilibrium can be supported where information is conveyed to the entrant through two signals, but also an uninformative equilibrium where information is concealed. The uninformative equilibrium emerges when both regulator and incumbent are willing to give up part of their first period payoffs in order to deter entry. If the regulator must commit to an emission fee across time, communication is further promoted. Therefore, our results identify a potential benefit of inflexible environmental policies, namely, hindering the ability of monopolists to practice entry deterrence.

Keywords: Entry deterrence, Signaling, Emission fees, Perfect commitment

JEL Classification: D82, H23, L12, Q5

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