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Chapter 17

Chapter 17 Full Notes

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ECON 1131
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Chapter 17 Public Policy and the Big Business Sector Effective Monopoly Power Barriers to Entry  Barrier to entry (or exit): anything that restricts or prevents the free flow of resources into or out of an industry to compete away existing economic profits  Barriers to entry are a distinguishing feature of all noncompetitive markets Three Categories of Barriers to Entry  Legal barrier to entry: any government policy, such as an exclusive franchise or a patent, that restricts or prevents the free flow of resources into or out of an industry o Ex: copyrights, licences, franchises, tariff, etc.  Natural barriers to entry: features inherent in production or supply, such as economies of scale and limited access to a vital factor of production, that restrict or prevent the free flow of resources into or out of an industry o Natural resources- industries that rely on nonreproductible natural resources, such as steel, aluminum, etc. often become structured as oligopolies with high barriers to entry o Economies of scale- the production of some products exhibits substantial economies of scale such that the minimum efficient scale of operation can only be achieved by a very large firm  Society would not want a large number of firms, each producing at very high costs  Where markets naturally regionalize, the MES encompasses the entire regional market (why utilities are referred to as natural monopolies)  No natural monopolies exist at the national level  Beer is an example  Behavioral barriers to entry: a strategic decision on the part of a firm that is specifically designed either to deter entry entirely or to accommodate entry by forcing new firms to enter on a smaller scale o Strategies that firms allegedly use are: product differentiation, predatory pricing, and investment in excess capacity o Successful product differentiation is inherently a barrier because it allows firms to capture certain customers and shields them from potential competitors o Predatory/limit pricing: a strategy used by an incumbent firm to deter entry in which the firm sets its price so low that a new entrant could not possibly compete with the firm and make a profit  Incumbent accepts short run losses for long run gains by lowering price hoping that new entrant will be unwilling to compete at the low price o Successful product differentiation is the only important behavioral barrier to entry- predatory pricing and investment in excess capacity aren’t effective Size and the Nature of Capital  Economists are becoming increasingly convinced that size alone is not enough to deter entry or restrict mobility  If economies of scale were the only barrier to entry, most oligopolies would support 10 or more equal sized firms- an industry with this many firms would likely be effectively competitive Commitment, Sunk Costs, and Irreversibility  Two key concepts in the modern analysis of barriers to entry are commitment and irreversibility  When investors decide to enter and industry, to what extent are they committed to that move? o The answer depends on how long a period of time the short run is for that industry, and the length of the short run depends in turn on the nature of the capital stock o The more specific the capital is to that industry, the longer the short run o The decision to enter an industry with a long short run is an irreversible decision that commits the investors to that industry for a number of years  Firms that are first movers can set their price > avg variable cost, and
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