Optimal Firm Entry with Returns to Scale

Anup Mulay () and Anthony Savagar ()
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Anup Mulay: Lietuvos Bankas
Anthony Savagar: University of Kent

No 129, Bank of Lithuania Working Paper Series from Bank of Lithuania

Abstract: We study the welfare implications of distortions, such as markups and returns to scale, when firm entry is slow to adjust, allowing quasi-rents to persist for longer. First, we present evidence on differences in speed of firm entry adjustment across US industries. In some industries, such as hospitality, firms respond rapidly to profit opportunities, arbitraging quasi-rent quickly. Whereas, in other industries, such as construction, entrants respond slowly, sustaining incumbents’ quasi-rents for longer. We develop a model of sluggish firm adjustment, which shows that the sluggishness of firm adjustment magnifies the welfare costs of distortions. We study a model with a fixed cost and increasing marginal cost such that a perfectly competitive equilibrium exists, and in the absence of distortions market and planner equilibrium coincide with firms operating at minimum efficient scale. We contrast outcomes when there is curvature on the demand-side of the economy from markups and curvature on the supply-side of the economy from returns to scale, adding counter-evidence to the perception that the setups are isomorphic.

Keywords: Markups; Firm Entry; Returns to Scale; Welfare (search for similar items in EconPapers)
JEL-codes: C62 D21 D43 E32 L13 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2025-01-17
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