``Costless'' regulation of monopolies with large entry cost: A game theoretic approach (Q1293480)

The paper analyzes a model in which a product, which can potentially be produced by a large number of firms, requires, however, a very large entry cost which makes it unprofitable for more than one firm to operate and thus leads to the formation of a natural monopoly. The authors consider a four stage game in which the players are the regulator, the incumbent monopolist, and infinitely many potential entrants. It is a symmetric game, that is, with identical cost functions, except that the entry cost is a sunk cost for the incumbent. In the first stage of the game the regulator announces the size of a subsidy that it is prepared to pay to any new entrant. In the second stage, knowing the promised subsidy level, the incumbent has to commit itself to an output, a commitment which is assumed to be enforceable by the regulator. In the third stage, the potential entrants decide whether or not to enter and, in the last stage of the game, the entrants engage in a Cournot equilibrium, that is, given the incumbent's announced output and the other firms's decisions, the entrant decides on its profit maximizing output. The regulator maximizes the sum of consumer and producer surplus, net of subsidy paid. The authors analyze the pure strategy sub-game perfect Nash equilibria of this game. The main conclusion is that there is an unique equilibrium in which there is no entry and price equals marginal cost. Therefore, the first best solution is attained at no subsidy cost. The game is one of full information, though there are some exceptional cases in which the information requirement need only be partial.