Discussion Paper Details

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Title: Market Size and Competition: A "Hump-Shaped" Result

Author(s): Iris Grant, Iris Kesternich, Heiner Schumacher and Johannes Van Biesebroeck

Publication Date: September 2019

Keyword(s): Competition, Entry Threshold Ratio, Market entry and market size

Programme Area(s): Industrial Organization

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.

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Bibliographic Reference

Grant, I, Kesternich, I, Schumacher, H and Van Biesebroeck, J. 2019. 'Market Size and Competition: A "Hump-Shaped" Result'. London, Centre for Economic Policy Research.