Network Externalities and Friendly Neighbors: When Firms Choose to Invite Competition

Abstract

Economic theory on the subject of barriers to entry focuses almost exclusively on firms seeking to preserve market power and economic profits. In this paper, we propose that, under certain circumstances, firms may instead choose to reduce barriers to entry as a profit-maximizing mechanism. We model this behavior and show that, under certain conditions, profit can increase for some existing firms as the number of firms in the industry increases. We provide evidence of this behavior from three distinct industries: personal computers, non-petroleum cars and professional American football.

Keywords: entry and exit, network externalities, industry structure, barriers to entry

JEL Classification: D43, L11, L13, L24, O32