Entry Dynamics: Theory and Implications

Abstract

Entry and exit behavior of firms tends to determine the pattern of industry evolution. Industries grow when new firms enter the industry; they decline when the incumbent firms exit. The entry process necessarily involves competition between the incumbent and the new entrants. Models of perfect competition where firms are price takers, assume that entry and exit are more or less costless and under conditions of free flow of market information this yields an industry equilibrium. The Walrasian model of competitive equilibrium introduces two types of adjustments: price—cost adjustment and demand—supply adjustment. First, if price exceeds marginal cost where the latter could be viewed as minimal average cost, the profitability continues and this provides incentives for new firms to enter the market till the excess profits are eliminated by new entry. Secondly, if excess demand persists and the capacity ceiling is hit, prices tend to rise thus causing profits to rise. This again provides incentives for new entry or the expansion of output by the existing incumbents.