The barriers to entry and exit into and out of the market are low In the short run the profits made by businesses competing in this type of market structure can be at any level - in our example above the business is making supernormal profits indicated by the shaded area. Monopolistic competition characterizes an industry in which many firms offer products or services that are similar, but not perfect substitutes. Under perfect competition, there is no restraint to entry of new firms to the business or … Tuteja (Lecture Notes, IIFT) Business Economics MBA IB (2020-22) Introduction What are Barriers to Entry and Exit? The sale of diamonds also suffered from rising awareness about blood diamonds. Types of barriers: Innocent barriers are those that are part and … This results in situations where there are substantial economies of scale. Roughly speaking, patent law covers inventions and copyright protects books, songs, and art. For example, imagine there are two firms in a natural monopoly’s market and each of them produces half of the quantity that the monopoly produces. In practice, monopolies rarely arise because of control over natural resources. After the company repeats this pattern once or twice, potential new entrants may decide that it is not wise to try to compete. Least cost firm as a price leader ... Losses are acceptable only in the short run, and lead to exit in the long run. Most legal monopolies are utilities—products necessary for everyday life—that are socially beneficial. Discuss different types of monopolies initiated by government. Consider a large airline that provides most of the flights between two particular cities. Network externalities (also called network effects) occur when the value of a good or service increases as a result of many people using it. Why are generic pharmaceuticals significantly cheaper than name brand ones? In a government monopoly, an agency under the direct authority of the government itself holds the monopoly. The reverse is also true. In contrast, a natural monopoly will have a marginal cost that is constant or declining, and an average total cost that drops as the quantity of output increases. Intellectual property refers to legally guaranteed ownership of an idea, rather than a physical item. No barriers to to entry or exit. . This provides an incentive for the continued creation of innovative goods. 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The state-owned petroleum companies that are common in oil-rich developing countries (such as Aramco in Saudi Arabia or PDVSA in Venezuela) are examples of government monopolies created through nationalization of resources and existing firms. Some industries require large investments in capital or research and development, making it difficult for new firms to enter. A monopolist faces no any competition, that all because the barriers of entry. Identify the legal conditions that lead to monopolistic power. Economies of size - The need for a large volume of production and sales to reach the cost level per unit of production for profitability is a barrier to entry. Control over natural resources that are critical to the production of a good is one source of monopoly power. Intellectual property – Patents, trademarks, service marks, and other types of proprietary intellectual property are very effective in limiting industry entry. Roughly 1.9 million trademarks are registered with the U.S. government. Some production processes require large investments in capital or large research and development costs that make it difficult for new companies to enter an industry. This is because when a person uses software that is used by so many others, he or she is less likely to run into compatibility problems in the course of work or other activities. Another type of natural monopoly occurs when a company has control of a scarce physical resource. Copyright Office, “is a form of protection provided by the laws of the United States for ‘original works of authorship’ including literary, dramatic, musical, architectural, cartographic, choreographic, pantomimic, pictorial, graphic, sculptural, and audiovisual creations.” No one can reproduce, display, or perform a copyrighted work without the author’s permission. A trademark is an identifying symbol or name for a particular good, like Chiquita bananas, Chevrolet cars, or the Nike “swoosh” that appears on shoes and athletic gear. Also, there are high barriers to entry and exit the market as a result not many sellers are able to enter the market. Countries around the world have enacted laws to protect intellectual property, although the time periods and exact provisions of such laws vary across countries. There are two types of monopoly, based on the kinds of barriers to entry they exploit. De Beers is a classic example of a monopoly based on a natural resource. Moreover, Stigler (1968) rejected the basic notion that scale economies can create an entry barrier. What is a barrier to entry? Barriers make a market less contestable - they determine the extent to which well-established firms can price above marginal and average cost in the long run. Barriers to Entry Definition. Barriers to entry. A firm can renew a trademark repeatedly, as long as it remains in active use. Another example is that the Digital Millenium Copyright Act the proprietary Macrovision copy prevention technology is required for analog video recorders. A firmly established brand name can be difficult to dislodge. A patent gives the inventor the exclusive legal right to make, use, or sell the invention for a limited time. Facebook: Network effects are one reason why it’s so difficult for new companies to compete against Facebook: they simply will have difficulty establishing a network of users to compete. Barriers to entry is an economics and business term describing factors that can prevent or impede newcomers into a market or industry sector, and so limit competition. In other instances, the government may be an invested partner in a monopoly rather than a sole owner. Key Terms • Monopoly (market) power • Deadweight social welfare loss • Antitrust law • Barriers to entry and exit • Natural monopoly • Regulatory capture theory There are no barriers to entry, or exit competition. Return to (Figure). Entry and Exit Decisions in the Long Run; Efficiency in Perfectly Competitive Markets; Chapter 25. A natural monopoly arises when economies of scale persist over a large enough range of output that if one firm supplies the entire market, no other firm can enter without facing a cost disadvantage. Natural monopolies tend to form in industries where there are high fixed costs. The legal system can grant firms monopoly rights over a resource or production of a good. Dominant firm as a price leader . Y2 10) Barriers to Entry and Exit (Sources of Monopoly Power). Social networks with the largest memberships are more attractive to new users, because new users know that their friends or colleagues are more likely to be on these networks. The large airline immediately slashes prices on this route to the bone, so that the new entrant cannot make any money. In the United States, exclusive patent rights last for 20 years. How do you suppose their barriers to entry were weakened? In a government monopoly, the holder of the monopoly is formally the government itself and the group of people who make business decisions is an agency under the government’s direct authority. Suppose a new firm with the same LRAC curve as the incumbent tries to break into the market by selling 4,000 units of output. One is legal monopoly, where laws prohibit (or severely limit) competition. Barriers to entry and exit exist, and, in order to ensure profits, a monopoly will attempt to maintain them. A copyright gives the creator of an original creative work exclusive rights to it for a limited time. There are two types of government-initiated monopoly: a government monopoly and a government-granted monopoly. Economies of scale are cost advantages that large firms obtain due to their size.They occur because the cost per unit of output decreases with increasing scale, as fixed costs are spread over more units of output. What products we consider utilities depends, in part, on the available technology. One is natural monopoly, where the barriers to entry are something other than legal prohibition. Barriers to entry are factors that make it difficult for new firms to enter the market. There are several different types of barriers to entry. There are relatively insignificant barriers to entry or exit, and success invites new competitors into the industry. (We introduced this theme in Production, Cost and Industry Structure). Ownership of key resources or raw material: Having control over scarce resources, which other firms could have used, creates a very strong barrier to entry. While other word processing programs may be available, an individual would risk running into compatibility problems when sending files to people or machines using the mainstream software. Next: How a Profit-Maximizing Monopoly Chooses Output and Price, Creative Commons Attribution 4.0 International License, Government often responds with regulation (or ownership), Post office, past regulation of airlines and trucking, Yes, through protection of intellectual property, Predatory pricing; well-known brand names. Barriers to entry are economic, procedural, regulatory, or technological factors that obstruct or restrict entry of new firms into an industry or market. As a result, they would each have to raise prices to cover their higher costs. For example, cement production exhibits economies of scale, and the quantity of cement demanded in a local area may not be much larger than what a single plant can produce. In other cases, they may limit competition to a few firms. The United States Postal Service is another example of a government monopoly. Legal rights can provide an opportunity to monopolize a market for a good. It convinced independent producers to join its single channel monopoly. A natural monopoly ‘s cost structure is very different from that of most industries. A natural monopoly arises as a result of economies of scale. One famous trade secret is the formula for Coca-Cola, which is not protected under copyright or patent law, but is simply kept secret by the company. (They would each have to build their own power lines.) It becomes most efficient for production to be concentrated in a single firm. The laws that protect intellectual property include patents, copyrights, trademarks, and trade secrets. A firm with high fixed costs requires a large number of customers in order to have a meaningful return on investment. Barriers to entry will make a market less competitive. Once the electric company installs lines in a new subdivision, the marginal cost of providing additional electrical service to one more home is minimal. Now consider the market demand curve in the diagram, which intersects the long-run average cost (LRAC) curve at an output level of 5,000 planes per year and at a price P1, which is higher than P0. It shows economies of scale up to an output of 8,000 planes per year and a price of P0, then constant returns to scale from 8,000 to 20,000 planes per year, and diseconomies of scale at a quantity of production greater than 20,000 planes per year. One method is known as predatory pricing, in which a firm uses the threat of sharp price cuts to discourage competition. Around the world, government monopolies on public utilities, telecommunications systems, and railroads have historically been common. In a government-granted monopoly, on the other hand, the monopoly is enforced through the law, but the holder of the monopoly is formally a private firm, which makes its own business decisions. Monopoly. During the term of the patent, the patent holder has the right to exclude others from making, using, or selling the patented invention. Suppose P0 is $10 and P1 is $11. What Is Economics, and Why Is It Important? Monopolies have relatively high barriers to entry. This allows the company to recoup the cost of developing this particular drug. Businesses have developed a number of schemes for creating barriers to entry by deterring potential competitors from entering the market. A firm with high fixed costs requires a large number of customers in order to have a meaningful return on investment. Predatory pricing is a violation of U.S. antitrust law, but it is difficult to prove. The greater the number of people using the specific good or service the greater the individuals benefit. What legal mechanisms protect intellectual property? International trade is an additional source of competition for owners of natural resources. Identify the common conditions that lead to monopolistic power. Thus, in markets with significant barriers to entry, it is not necessarily true that abnormally high profits will attract new firms, and that this entry of new firms will eventually cause the price to decline so that surviving firms earn only a normal level of profit in the long run. One is natural monopoly, where the barriers to entry are something other than legal prohibition. In this world of near ubiquitous information, other companies could take the formula, produce the drug, and because they did not incur the costs of research and development (R&D), undercut the price of the company that discovered the drug. When barriers to entry are high enough, monopoly can result. Shorter patent protection would make innovation less lucrative, so the amount of research and development would likely decline. The intent behind copyright is to promote the creation of new works by providing creators the opportunity to profit from their works. Distinguish between a natural monopoly and a legal monopoly. This makes competing goods or services with lower levels of adoption unattractive to new customers. (Figure) presents a long-run average cost curve for the airplane manufacturing industry. There are ongoing negotiations, both through the World Intellectual Property Organization (WIPO) and through international treaties, to bring greater harmony to the intellectual property laws of different countries to determine the extent to which those in other countries will respect patents and copyrights of those in other countries. When barriers to entry exist, perfect competition is no longer a reasonable description of how an industry works. Estimate from the graph what the new firm’s average cost of producing output would be. For both of these, fixed costs of building the necessary infrastructure are high. Additionally, the Dutch East India Company provides a historical example of a government-granted monopoly. A city passes a law on how many licenses it will issue for taxicabs, A city passes a law that all taxicab drivers must pass a driving safety test and have insurance, Owning a spring that offers very pure water, An industry where economies of scale are very large compared to the size of demand in the market. These barriers may be due to legal restrictions like licensing or patent rights or due to restrictions created by firms in the form of cartel. Barriers to entry exist. In a government-granted monopoly, the government gives a private individual or a firm the right to be a sole provider of a good or service. At that case the economies of scale act as barrier to enter industry. One is natural monopoly, where the barriers to entry are something other than legal prohibition. The government creates legal barriers through patents, copyrights, and granting exclusive rights to companies. Firms gain monopolistic power as a result of markets' barriers to entry, which discourage potential competitors. Natural Monopoly: The total cost of the natural monopoly’s production is lower than the sum of the total costs of two firms producing the same quantity. For example, in many countries, the postal system is run by the government with competition forbidden by law in some or all services. There are no barriers to entry. In Michael Porter’s model of competitive analysis, barriers are a fundamental element to gauge the level of competition in a sector, and relates … Examples of barriers to entry There are two types of monopoly, based on the types of barriers to entry they exploit. There is a need for multiple buyers and sellers. The granting of permits or professional licenses can also favor certain firms, while setting standards that are difficult for new firms to meet. Some of the common barriers to entry and exit are listed below. Once an entrepreneur or firm has purchased the rights to all of them, no new competitors can enter the market. A network effect is the effect that multiple users have on the value of a good or service to other users. Take the example of diamond and gold markets. 2. How is intellectual property different from other property? The patent provides incentives (1) to invent in the first place, (2) to disclose the invention once it is made, (3) to make the necessary investments in research and development, production, and bringing the invention to market, and (4) to innovate by designing around or improving upon earlier patents. Economies of scale and network externalities are two types of barrier to entry. As another example, the majority of global diamond production is controlled by DeBeers, a multi-national company that has mining and production operations in South Africa, Botswana, Namibia, and Canada. This is probably not a barrier to entry, since there are a number of different ways of getting pure water. Modern technology in certain industry is such that extensive economies of scale exist. Postal Service: The postal service operates as a government monopoly in many countries, including the United States. Predatory pricing, as well as an acquisition: A firm may deliberately lower prices to force rivals out of the market. Economies of Scale: Large firms obtain economies of scale in part because fixed costs are spread over more units of output. The cost of constructing a competing transmission network and delivering service will be so high that it effectively bars potential competitors from entering the monopolist’s market. A new, small start-up airline decides to offer service between these two cities. Even if you do have the capital, the worry that you will be stuck in an unprofitable situation with a lot of unrecoverable capital invested in the business may stop you entering the market in the first place. This is short run entry into a contestable market seeking to take some of the monopoly profits available and then exiting just as quickly. The higher the barriers to entry and exit, the more prone a market tends to be a natural monopoly. PC markets have free entry and exit. Barriers to entry are natural or legal restrictions that restrict the entry of new firms into the business world. This is a government-enforced barrier to entry. The government can provide exclusive or special rights to companies that legally allow them to be monopolies. In other words, resource control allows the controller to charge economic rent. Copyright gives the creator of an original creative work (such as a book, song, or film) exclusive rights to it, usually for a limited time, with the intention of enabling the creator to be compensated for his or her work. Government limitations on competition used to be more common in the United States. These 'unrecoverable' costs are often referred to as sunk costs. Natural monopolies arise as a result of economies of scale. Economies of scale and network externalities discourage potential competitors from entering a market. Entry barriers (or barriers to entry) are obstacles that stop or prevent the entrance of a firm in a specific market. As mentioned above, this can act as a barrier to exit as well as a barrier to entry. If a second firm attempts to enter the market at a smaller size, say by producing a quantity of 4,000 planes, then its average costs will be higher than those of the existing firm, and it will be unable to compete. A natural monopoly occurs when the quantity demanded is less than the minimum quantity it takes to be at the bottom of the long-run average cost curve. If the second firm attempts to enter the market at a larger size, like 8,000 planes per year, then it could produce at a lower average cost—but it could not sell all 8,000 planes that it produced because of insufficient demand in the market. De Beers had a lot of market power in the world market for diamonds over the course of the 20th century, keeping the price of diamonds high. #2 Artificial (Strategic) Barriers to Entry. There are two types of monopoly, based on the types of barriers to entry they exploit. If barriers to entry are very high then the market will invariably become a monopoly. After the patent expires, any pharmaceutical company can manufacture and sell a generic version of the drug, bringing down the price of the original drug to compete with new versions. 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