Endogenous Market Structures and Welfare by Federico Etro

Endogenous Market Structures and Welfare by Federico Etro University of Venice, Ca’ Foscari Saint Petersburg, October 2012 HSE Center of Market Studies and Spatial Economics

On theory of EMS: • Strategic interactions between few firms and endogenous entry • Folk theory on Cournot with EMS • Dasgupta-Stiglitz (1980) • Sutton bounds approach and Gabszewicz-Thisse • Mankiw-Whinston (1986) excess entry result on welfare properties of EMS with homogenous goods

On theory of EMS: • Dixit-Stiglitz (1977) monopolistic competition w/o strategic interactions and w CES preferences Ø Krugman (1980) on trade Ø Blanchard-Kiyotaki (1986) on macroeconomics Ø Romer (1990) on growth • What about welfare? Not much with CES: the eq. Is a second best • Beyond CES: Zhelobodko et al. (2012)!!

General EMS model Size of the economy: E Profits of firm i: Ex: quantity competition with homogenous or differentiated goods (x= quantity); price competition with Dixit-Stiglitz, exponential demand (1/x=price)

General EMS model EMS is characterized by x and n that satisfy: Example: Cournot, hyperbolic demand p=1/X and marginal cost c:

On theory of EMS: • Leadership with free entry Ø Dominant firm approach Ø Bain-Sylos Labini-Modigliani Approach Ø Contestable market approach • Stackelberg competition with endogenous entry (Etro, 2004, 2008, EJ; Anderson, Erkal and Piccinin, 2012)

Leadership with endogenous entry

On theory of EMS: • Strategic investments (Etro, 2006, Rand) • Mergers (Davidson and Mukherjee, 2007, IJIO; Erkal and Piccinin, 2010, ER) • Vertical and incentive contracts and bundling (Etro, 2011, EER) • Beneficial concentration (Ino and Matsumura, 2012, IER) • Financial structure (Etro, 2010, CJE) • what about welfare? Neutrality examples with CES

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Traditional approach to market analysis: Structure Conduct Performance

EMS approach to market analysis: Conduct Size Structure Performance

On theory of EMS: • Dixit-Stiglitz (1977) with strategic interactions and CES preferences Ø on trade (Etro, 2011 wp) Ø on macroeconomics (Etro and Colciago, 2010, EJ; Bilbiie et al. , 2012, JPE) Ø on growth (Peretto, 1996; 2003)

Questions: - An EMS is characterized by too many firms and too little production? - The strategies of a leader are beneficial or detrimental to consumer surplus?

The Model - Utility - Budget constraint - FOC

Bertrand competition - Demand - Profits:

- since - we can solve for the symmetric eq. price: - and profits:

EMS - Number of firms: - Strategies:

Welfare analysis: - Comparison with the Dixit-Stiglitz second best - excess entry if: - neutrality of CS to leaders only under CES

Cournot competition - Inverse demand - Profits: - We can solve for the symmetric eq. quantity:

- we can solve for the symmetric eq. price: - and profits: - EMS:

Welfare analysis: - Comparison with the Dixit-Stiglitz second best - excess entry if:

Welfare analysis: - competition fixes independently from the strategy of the leader - therefore the number of firms is: - so CS increases when the leader plays if:

Welfare analysis:

Welfare analysis: - in general what matters is the elasticity of the utility: - Implications for strategic investments, mergers, vertical contracts, bundling, concentrations. .

Conclusions - Excess entry holds more in general and is pervasive: - Dynamic inefficiency in dynamic models - also with endogenous R&D (Vives, 2008) - Leaders are CS-neutral with CES preferences ONLY - Aggressive quantity-leaders are CSincreasing when the elasticity of utility is decreasing