Market entry and foreign direct investment

The welfare economics of foreign direct investment (FDI) are addressed in a model of two countries and two periods. In the first period, firms enter markets as national firms, in the second period, FDI is possible. The paper demonstrates that FDI reduces market entry in the first period and equilibrium profits in the second period. Compared to a trade regime without any FDI, prices are higher in the first period but lower in the second period. FDI unambiguously improves the sum of discounted consumer surplus if demand functions are linear or log-linear and entry is free in the first period. (c) 2005 Elsevier B.V. All rights reserved.