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Is a Big Entrant a Threat to Incumbents? The Role of Demand Substitutability in Competition Among the Big and the Small

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  • Lijun Pan
  • Makoto Hanazono

Abstract

We establish a model of market competition between large and small firms and investigate the way in which demand substitutability affects how the entry of big firms impacts incumbents. We focus on the relative strength of two opposing effects of entry on large incumbent firms’ demand: the direct substitution effect among large firms (negative) and the indirect feedback effect through the change in small firms’ aggregated behavior (positive). If the substitutability between large and small firms is sufficiently high, the indirect effect dominates the direct effect and large incumbents’ equilibrium prices and profits increase. We show that welfare effects are ambiguous, which calls for careful assessment when regulating large firms’ entry.

Suggested Citation

  • Lijun Pan & Makoto Hanazono, 2018. "Is a Big Entrant a Threat to Incumbents? The Role of Demand Substitutability in Competition Among the Big and the Small," Journal of Industrial Economics, Wiley Blackwell, vol. 66(1), pages 30-65, March.
    • Handle: RePEc:bla:jindec:v:66:y:2018:i:1:p:30-65
    DOI: 10.1111/joie.12164
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    Cited by:

    1. Pan, Lijun & Wang, Yongjin, 2020. "Competition among large and heterogeneous small firms," Economics Letters, Elsevier, vol. 196(C).
    2. Lijun Pan & Takatoshi Tabuchi, 2019. "Free Trade Agreement with Endogenous Market Structure," The Japanese Economic Review, Japanese Economic Association, vol. 70(4), pages 426-445, December.

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