Entry and Competition in Differentiated Products Markets
Catholic University of Leuven (KUL) - Department of Applied Economics; Centre for Economic Policy Research (CEPR)
April 15, 2011
TILEC Discussion Paper No. 2011-025
CentER Discussion Paper No. 2011-049
We propose a methodology for estimating the competition effects from entry when firms sell differentiated products. We first derive precise conditions under which Bresnahan and Reiss' entry threshold ratios (ETRs) can be used to test for the presence and to measure the magnitude of competition effects. We then show how to augment the traditional entry model with a revenue equation. This revenue equation serves to adjust the ETRs by the extent of market expansion from entry, and leads to unbiased estimates of the competition effects from entry. We apply our approach to seven different local service sectors. We find that entry typically leads to significant market expansion, implying that traditional ETRs may substantially underestimate the competition effects from entry. In most sectors, the second entrant reduces markups by at least 30%, whereas the third or subsequent entrants have smaller or insignificant effects. In one sector, we find that even the second entrant does not reduce markups, consistent with a recent decision by the competition authority.
Number of Pages in PDF File: 34
Keywords: competition, entry, local services sectors, entry threshold ratios
JEL Classification: K21, L13, L41working papers series
Date posted: April 22, 2011
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