Working Paper: CEPR ID: DP10080
Authors: Andrew Atkeson; Christian Hellwig; Guillermo Ordoñez
Abstract: In all markets, firms go through a process of creative destruction: entry, random growth and exit. In many of these markets there are also regulations that restrict entry, possibly distorting this process. We study the public interest rationale for entry taxes in a general equilibrium model with free entry and exit of firms in which firm dynamics are driven by reputation concerns. In our model firms can produce high-quality output by making a costly but efficient initial unobservable investment. If buyers never learn about this investment, an extreme `"lemons problem" develops, no firm invests, and the market shuts down. Learning introduces reputation incentives such that a fraction of entrants do invest. We show that, if the market operates with spot prices, entry taxes always enhance the role of reputation to induce investment, improving welfare despite the impact of these taxes on equilibrium prices and total production.
Keywords: Entry regulation; Firm dynamics; Quality investments; Reputation concerns
JEL Codes: D83; L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| entry taxes (H25) | reputation (M14) |
| reputation (M14) | investment in quality (L15) |
| investment in quality (L15) | welfare (I38) |
| entry taxes (H25) | investment in quality (L15) |
| entry taxes (H25) | welfare (I38) |
| entry fees and price subsidies (H23) | allocation close to first-best outcome (D61) |
| entry fees (D44) | welfare (I38) |
| price subsidies (H20) | welfare (I38) |
| entry fees (D44) | quality (L15) |
| price subsidies (H20) | quality (L15) |