Product Diversity, Strategic Interactions and Optimal Taxation
The entry of a new product increases consumer surplus through additional product di- versity but decreases firm profits. In markets where .rm entry intensi.es competition and reduces markups through strategic interactions, we expect entry to be excessively high. In a simple general equilibrium model, this is true for industries with very similar goods. If goods are instead highly differentiated, entry is below optimum. In both cases, the optimal policy is a labour subsidy and a tax on entry. If labour subsidies are unavailable, subsidising entry is optimal for industries with low degrees of product differentiation.