A Negative Effect of Cost-Reducing Public Investment: The Role of Firms' Entry

We investigate public infrastructure investment that reduces production costs in oligopoly markets. The government decides on its public investment based on conventional cost-benefit analysis that considers the direct effect (the benefit estimated as a reduction in production costs). If the entry barriers are significant, this estimation is conservative because the positive indirect effect of the subsequent production expansion is ignored. In free-entry markets, by contrast, the indirect effect can be negative depending on the demand and cost functions. Thus, conventional cost-benefit analysis is conservative in the presence of entry barriers, buy may be too optimistic without entry barriers.