A typical firm maximizes its profit. If incumbent firms make profits, new firms enter this industry. On the contrary, if an incumbent firm makes a loss, she exits from the industry. As a result of entry and exit of firms, a stable and stationary industrial structure is realized in the long run. It is called a long-run equilibrium or a free entry equilibrium.
Many researchers examine whether or not, in an oligopoly market, the long-run equilibrium number of firms is an efficient one from the viewpoint of social welfare. Von Weizacker(1980), first, proves the excess entry theorem. That is, the long-run equilibrium number of firms in the oligopoly market exceeds that of the second best equilibrium in which social surplus is maximized. Following his result, the excess entry theorem was extended in two directions. Mankiw & Whinston(1986) and Suzumura & Kiyono(1987) prove the excess entry theorem in the long-run equilibrium when the industry consists of homogeneous firms under generalized cost and demand conditions. Lahiri & Ono(1989) prove it in the short-run equilibrium when the industry consists of heterogeneous firms regarding their cost structures.
The purpose of this paper is to examine these previous results in a financial industry and to establish that the excess entry theorem is valid in a generalized framework. We consider financial institutions such as banks and consumer finance companies that raise funds and lend them to the individual customers. While Suzumura(1992) suggested the possibility of excess entry in a banking industry, he assumed homogeneous banks. We assume that the financial institutions are different in cost structure and investigate the long-run equilibrium. We derive the number of firms in the long-run Cournot equilibrium and compare it with that of the second best equilibrium in which the social welfare is maximized. We prove that the excess entry theorem holds in the long-run even if firms have different cost structures. Our result integrates both Mankiw & Whinston(1986), Suzumura & Kiyono(1987) and Lahiri & Ono(1989), and generalizes them.
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