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Free Entry and Social Inefficiency in Radio Broadcasting

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  • Steven Berry
  • Joel Waldfogel

Abstract

In theory, free entry can lead to social inefficiency. When new products are substitutes for existing products, the business stolen from incumbents places a wedge between private and social benefits of entry. The business stealing effect can be offset if entry reduces prices or increases available product variety. Our study of the radio industry provides one of the first empirical attempts to quantify the inefficiency associated with free entry. Using data on advertising prices, number of stations and radio listening in 135 U.S. metropolitan markets, we estimate how listening and revenue vary with the number of stations. Using a free-entry assumption, we infer the distribution of station costs, which are fixed with respect to listening. We then use our estimates of revenue and fixed costs to calculate the welfare of market participants (excluding listeners) and the number of stations under free entry and social optimality. Relative to the social optimum, the welfare loss of free entry is 40 percent of industry revenue. However, we calculate that the free entry equilibrium would be optimal if the marginal value of programming to listeners were over three times the value of marginal listeners to advertisers, who pay 4.5 cents per hour.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5528.

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Date of creation: Apr 1996
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Publication status: published as Rand Journal of Economics, Vol. 30, no. 3 (Autumn 1999): 397-420.
Handle: RePEc:nbr:nberwo:5528

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  1. Spence, Michael, 1976. "Product Selection, Fixed Costs, and Monopolistic Competition," Review of Economic Studies, Wiley Blackwell, vol. 43(2), pages 217-35, June.
  2. Berry, Steven T, 1992. "Estimation of a Model of Entry in the Airline Industry," Econometrica, Econometric Society, vol. 60(4), pages 889-917, July.
  3. Daniel McFadden, 1977. "Modelling the Choice of Residential Location," Cowles Foundation Discussion Papers 477, Cowles Foundation for Research in Economics, Yale University.
  4. N. Gregory Mankiw & Michael D. Whinston, 1986. "Free Entry and Social Inefficiency," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 48-58, Spring.
  5. ANDERSON, Simon P. & DE PALMA, André & NESTEROV, Yurii, 1994. "Oligopolistic Competition and the Optimal Provision of Products," CORE Discussion Papers 1994034, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  6. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
  7. Spence, Michael, 1976. "Product Differentiation and Welfare," American Economic Review, American Economic Association, vol. 66(2), pages 407-14, May.
  8. David Dranove & Mark Shanley & Carol Simon, 1992. "Is Hospital Competition Wasteful?," RAND Journal of Economics, The RAND Corporation, vol. 23(2), pages 247-262, Summer.
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