Competition is commonly thought of as both economically and politically desirable, ensuring efficiency and bolstering welfare. Regulation of markets, if required at all, should ensure unrestricted access and prevent oligopolies. Imperfect competition, on the contrary, is considered to be a form of market failure and a source of welfare loss.
However, this reasoning may be flawed, as BCCP Doctoral Student Colin von Negenborn shows in a recent study. Limiting competition by restricting the size of a market can, in fact, be welfare enhancing. He presents a model computing the optimal size of a given market - that is, determining the number of competitors at which the overall welfare is maximised. Thus, a regulator may prefer to curtail market entry rather than to foster it.
This surprising finding stems from the interplay of two countervailing forces. If a market is opened up and additional competitors enter, a two-fold effect arises. On the one hand, competition tightens, which drives down prices and benefits consumers. On the other hand, average production efficiency decreases, reducing welfare on both the supply and the demand sides. In his work, von Negenborn analyses when the net effect is negative, i.e. when market size restrictions are required to maximise welfare.
Regulatory policies can benefit from these insights. Oftentimes, regulation is sought to govern the entry to a market but not the price setting within a market, thus specifying the number of competitors but not their respective pricing. Examples range from spectrum auctions for telecommunications to licenses for private television broadcasters. For each of these markets, the present research can aid regulatory bodies in specifying the optimal size, showing when market entry should be restricted.
The full paper is available as CRC TRR 190 Discussion Paper No. 183 (Open access pdf download).