Working Paper: CEPR ID: DP14009
Authors: Iris Grant; Iris Kesternich; Heiner Schumacher; Johannes Van Biesebroeck
Abstract: An active empirical literature estimates entry threshold ratios, introduced by Bresnahan and Reiss (1991), to learn about the impact of firm entry on the strength of competition. These ratios measure the increase in minimum market size needed per firm to sustain one additional firm in the market. We show that there is no monotonic relationship between a change in the entry threshold ratio and a change in the strength of competition or in the price-cost margin. In the standard homogenous goods oligopoly model with linear or constant elasticity demand, the ratio is hump-shaped in the number of active firms, increasing at first and only when additional firms enter it gradually decreases and converges to one. Empirical applications should use caution and interpret changes in the entry threshold ratios as indicative of changes in competition only from the third entrant onwards.
Keywords: competition; market entry; market size; entry threshold ratio
JEL Codes: D43; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| entry threshold ratio (ETR) (C24) | strength of competition (L13) |
| entry threshold ratio (ETR) (C24) | price-cost margins (D40) |
| number of firms (L20) | entry threshold ratio (ETR) (C24) |
| entry threshold ratio (ETR) after 2nd entrant (C24) | entry threshold ratio (ETR) after 3rd entrant (C24) |
| entry threshold ratio (ETR) for the 3rd entrant (C24) | competition (L13) |