Our results and methods can be applied to the computational and empirical analysis of market structure and competition.
This paper considers the effects of raising the cost of entry for a potential competitor on infinite-horizon Markov-perfect duopoly dynamics with ongoing demand uncertainty. All entrants serving the model industry incur sunk costs, and exit avoids future fixed costs. We focus on the unique equilibrium with last-in first-out expectations— a firm never exits leaving behind an active younger rival— and confirm our results for a version of the model in which firms move simultaneously. We prove that raising a second producer’s sunk entry cost in an industry that supports at most two firms reduces the probability of having a duopoly but increases the probability that some firm will serve the industry. Numerical experiments indicate that a barrier to entry’s quantitative relevance depends crucially on properties of the demand process. If demand shocks are more persistent, a barrier to entry has smaller effects on the second entrant’s entry decision rule and the probability of observing a duopoly. With larger variance of demand, a barrier’s effect on the market structure is similarly reduced, even though the second firm’s entry decision is now affected more. This confirms Carlton’s (2004) assertion that the effects of a barrier depend crucially on industry dynamics that two- stage “short run/long run” models capture poorly.