Gatekeeping, Selection, and Welfare

We study staged entry with costly gatekeeping in a differentiated-products economy: entrepreneurs observe noisy signals before paying a resource-intensive activation cost. Precision improves selection but requires more resources, reducing entry and variety: welfare need not rise with precision. Under CES preferences, the activation cutoff is efficient as profit displacement offsets the consumer-surplus gain from variety. Welfare losses arise from verification costs shrinking the feasible set of varieties, not from misaligned incentives. Because the market responds efficiently to any given regime, these losses cannot be corrected via Pigouvian taxes.

💡 Research Summary

The paper develops a theoretical model of staged entry in a differentiated‑products market, extending the closed‑economy Melitz (2003) framework by adding a costly gate‑keeping stage. Entrepreneurs first incur a fixed experimentation cost (f_n) to observe a noisy signal (\theta) about their true productivity (\phi). The signal is informative in the sense that higher (\theta) first‑order stochastically dominates lower (\theta) (Assumption 1). After observing (\theta), the entrepreneur decides whether to pay an activation cost (f_b(\rho)) and enter production; the activation cost depends on the precision parameter (\rho\in(0,1)), with higher precision requiring more resources (Assumption 2). True productivity is revealed only after activation, and firms produce if profitable, otherwise they exit.

The model assumes CES consumer preferences with elasticity of substitution (\sigma>1) and a unit labor endowment. Production uses a fixed input requirement (f) plus variable input proportional to output, yielding the standard Melitz scaling: revenue and profit of a firm with productivity (\phi) are proportional to (\phi^{\sigma-1}) and (\phi^{\sigma-1}-1), respectively. A zero‑profit productivity cutoff (\phi^) is defined by (\pi(\phi^)=0).

Equilibrium is characterized by two conditions. The Activation Condition (AC) sets the signal cutoff (\theta^*) such that the expected discounted profit from a marginal firm equals the activation cost: \