This paper considers the effects of raising the cost of entry for a potential competitor
on infinite-horizon Markov-perfect duopoly dynamics with ongoing demand uncertainty.
All entrants serving the model industry incur sunk costs, and exit avoids future fixed
costs. We focus on the unique equilibrium with last-in first-out expectations: A firm
never exits leaving behind an active younger rival. We prove that raising a second
producer’s sunk entry cost in an industry that supports at most two firms reduces the
probability of having a duopoly but increases the probability that some firm will serve
the industry. Numerical experiments indicate that a barrier to entry’s quantitative
relevance depends on demand shocks’ serial correlation. If they are not very persistent,
the direct entry-deterring effect of a barrier to a second firm’s entry greatly reduces
the average number of active firms. The indirect entry-encouraging effect does little
to offset this. With highly persistent demand shocks, the direct effect is small and the
barrier to entry has no substantial effect on the number of competitors. This confirms
Carlton’s (2004) assertion that the effects of a barrier depend crucially on industry
dynamics that two-stage “short run/long run” models capture poorly.