Gatekeeping, Selection, and Welfare

TL;DR

This paper analyzes how costly gatekeeping and signal precision affect market entry, variety, and welfare in a differentiated-products economy, revealing that verification costs can lead to welfare losses despite efficient market responses.

Contribution

It introduces a model of staged entry with noisy signals and costly verification, showing how increased precision impacts welfare and market variety.

Findings

Higher verification costs reduce market entry and variety.

Welfare can decline with increased signal precision due to verification costs.

Market responses are efficient, so welfare losses cannot be corrected by taxes.

Abstract

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.