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Chapter 20.docx

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ECON 1010
Sarrah Vakili

Chapter 20: Barriers to entry – protecting monopoly power in the long run Barriers to entry are designed to block potential entrants from entering a market profitably. They seek to protect the power of existing firms and maintain supernormal profits / increase producer surplus. These barriers have the effect of making a market less contestable - they are also important because they determine the extent to which established firms can price above marginal and average cost in the long run. The 1982 Nobel Prize winning economist George Stigler defined an entry barrier as “A cost of producing which must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry”. Another Economist, George Bain defined entry barriers in a slightly different way “The extent to which established firms can elevate their selling prices above the minimal average costs of production without inducing potential entrants to enter an industry”. This emphasises the asymmetry in costs that often exists between the incumbent firm (i.e. the business with market power already inside the market) and the potential entrant. If the existing businesses have managed to exploit economies of scale and therefore developed a cost advantage over potential entrants, this advantage might be used to cut prices if and when new suppliers enter the market. This involves a decision to move away from short run profit maximisation objectives – but it is designed to inflict losses on new firms and thereby protect a dominant market position in the long run. The monopolist might then revert back to profit maximization once a new entrant has been rebuffed! Different types of entry barriers exist: o Structural barriers (innocent entry barriers) – arising from differences in production costs o Strategic barriers (see the notes below on strategic entry deterrence) o Statutory barriers - entry barriers given force of law (e.g. patent protection of franchises such as the National Lottery or television and radio broadcasting licences) Entry barriers exist when costs are higher for an entrant than for the incumbent firms. This is shown in the next diagram: In the previous diagram we assume that the incumbent monopolist has achieved economies of scale so that that its own LRAC and LRMC are lower than that of a potential entrant. If the monopolist maintains a profit maximising price of P1, a market entrant could achieve economic profits since its costs are lower than the prevailing price. At any price below Pe the potential entrant will make a loss – and entry can be blockaded. Barriers to Exit - Sunk Costs Sunk costs cannot be recovered if a business decides to leave an industry. Examples include:  Capital inputs that are specific to an industry and which have little or no resale value.  Money spent on advertising, marketing and research and development projects which cannot be carried forward into another market or industry. When sunk costs are high, a market becomes less contestable. High sunk costs act as a barrier to entry of new firms (they risk making huge losses if they decide to leave a market). In contrast, markets such as fast-food restaurants, sandwich bars, hairdressing salons and local antiques markets have low sunk costs so the barriers to exit are low. The frequent market entry and failure
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