Indeterminacy of free entry equilibria: general approach and macroeconomic applications

Free entry equilibria are usually determined by resorting to the zero profit condition. We plead instead for a strict application of the Nash equilibrium concept to a symmetric one-stage game played by actual and potential producers, who have a decreasing average cost function without sunk costs. Equilibrium then appears as typically indeterminate, with a number of active firms varying between an upper bound imposed by profitability and a lower bound required by sustainability. This indeterminacy may have significant macroeconomic implications, since it opens the way to coordination failures and to the emergence of endogenous fluctuations generated by the coordination process. The paper presents a general framework for the analysis of free entry equilibria, applies this framework to the standard regimes of price and quantity competition used in macroeconomic modelling, and illustrates dynamic aggregate implications in a simple macroeconomic model. JEL classification number: D43, L13.