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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
5528.
Length: Date of creation: Apr 1996 Date of revision: Handle: RePEc:nbr:nberwo:5528
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Find related papers by JEL classification: L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets L82 - Industrial Organization - - Industry Studies: Services - - - Entertainment; Media
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