Free Entry under Uncertainty
When focusing on firm’s risk-aversion in industry equilibrium, the number of firms may be either larger or smaller when comparing market equilibrium with and without price uncertainty. In this paper, we introduce risk-averse firms under cost uncertainty in a model of spatial differentiation and show that the impact of uncertainty will increase the number of firms in an industry. With increased uncertainty, the risk premium of the marginal buyer increases by more than the risk premium of the average buyer, so that the price increases by more than the risk premium. When turning to the free entry game, we find that the market generates too many firms.
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Volume (Year): 85 (2005)
Issue (Month): 1 (07)
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