Taxation, Network Externalities, Consumer Suffering, and Profit-Raising Entry: A Cautionary Note

Conventional wisdom is that higher competition, implying more active firms, benefits consumers but hurts producer surplus. Under unit taxation/subsidy, we find that the entry of efficient firms improves consumer welfare, while the entry of inefficient firms hurts consumer surplus with network externalities. The entry of efficient firm raises industry profit if the degree of network externalities is relatively high. The latter result is at odds with the conventional wisdom and showed another channel for the possibility of a profit-raising entry. Our results suggest that the strength of network effects should be considered for designing taxation/subsidy and competition policies concurrently.