AN INFORMATIONAL EXTERNALITY IN A COMPETITIVE MARKET

Consider a (new) competitive market with unknown demand. The market pr ice generated by incumbents conveys information that firms, including potential entrants, use for future decisions. Yet the incumbents are n ot rewarded for their assistance, suggesting that an inefficiency can exist. It has been argued that greater entry generates more informatio n about a new market and should be subsidized. A simple model of parti al information and learning is developed, finding that an informationa l externality can exist in competitive markets, but there may be exces sive entry. Free entry and a public price, conditions for competitive market efficiency, are conditions for inefficiency.