Working Paper: CEPR ID: DP8353
Authors: Catherine Schaumans; Frank Verboven
Abstract: 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.
Keywords: competition; entry; local service sectors
JEL Codes: L13; L41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| number of firms (L20) | market size (L25) |
| entry into local service markets (L89) | market expansion (F61) |
| second entrant (L26) | markups (D43) |
| third or subsequent entrants (L26) | markups (D43) |
| second entrant in specific sector (L26) | markups (D43) |