Excess Entry, Entry Regulation, and Entrant's Incentive

Excess entry theorem, which shows that the free market can generate too many firms, is a theoretic base for entry regulation. When the current market is a monopoly, entry is considered as excessive if the social welfare under the post-entry Cournot-Nash equilibrium, net of entry coast, is lower than that under monopoly. However, this paper argues that, even if this is true, limiting entry is not an optimal choice of the benevolent government. The entrant has an incentive to produce more than the Cournot-Nash equilibrium output level to get an entry permission as long as it is still profitable to enter. Therefore, an entry regulation which imposes entry condition, rather than just limiting entry, that the new entrant produces enough to make entry welfare increasing, will be an optimal regulation against excess entry problem. Limiting entry based on the excess entry theorem is a wrong policy, since it ignores the strategic reaction by the new entrant. Entry regulation can cure excess entry problem not by limiting entry but by imposing conditions on entry, since the latter is equivalent to a price regulation on the imperfect post-entry oligopoly market.