DOMESTIC WELFARE EFFECTS OF THE ENTRY OF A FOREIGN FIRM

Abstract

The entry of a foreign firm has two counterbalancing effects on domestic social welfare. As the competition level in the domestic market increases by the entry, domestic incumbent firms’ outputs and profits decrease. On the other hand, the price goes down and thus consumers’ surplus increases. Therefore, the effect of the entry of a foreign firm on domestic social welfare is determined by the relative size of these two opposite effects. By investigating this trade-off, we identify domestic market characteristics and types of foreign entrant that are likely to affect domestic social welfare positively. Our main findings can be summarized as follows. First, a foreign firm’s entry is less(more) likely to improve domestic social welfare as the pre-entry overall efficiency level of domestic market is higher(lower). Second, the foreign entrant should be more efficient than domestic firms. Otherwise, domestic social welfare decreases.