Barriers to entry

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In theories of competition in economics, a barrier to entry, or an economic barrier to entry, is a fixed cost that must be incurred by a new entrant, regardless of production or sales activities, into a market that incumbents do not have or have not had to incur. [1] [2] Because barriers to entry protect incumbent firms and restrict competition in a market, they can contribute to distortionary prices and are therefore most important when discussing antitrust policy. Barriers to entry often cause or aid the existence of monopolies and oligopolies, or give companies market power.

Contents

Definitions

Various conflicting definitions of "barrier to entry" have been put forth since the 1950s, and there has been no clear consensus on which definition should be used. This has caused considerable confusion and likely flawed policy. [1] [3] [4]

McAfee, Mialon, and Williams list seven common definitions in economic literature in chronological order including: [1] [5]

In 1956, Joe S. Bain used the definition "an advantage of established sellers in an industry over potential entrant sellers, which is reflected in the extent to which established sellers can persistently raise their prices above competitive levels without attracting new firms to enter the industry." McAfee et al. criticized this as being tautological by putting the "consequences of the definition into the definition itself."

In 1968, George Stigler defined an entry barrier as "A cost of producing that must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry." McAfee et al. criticized the phrase "is not borne" as being confusing and incomplete by implying that only current costs need be considered.

In 1979, Franklin M. Fisher gave the definition "anything that prevents entry when entry is socially beneficial." McAfee et al. criticized this along the same lines as Bain's definition.

In 1994, Dennis Carlton and Jeffrey Perloff gave the definition, "anything that prevents an entrepreneur from instantaneously creating a new firm in a market." Carlton and Perloff then dismiss their own definition as impractical and instead use their own definition of a "long-term barrier to entry" which is defined very closely to the definition in the introduction.

A primary barrier to entry is a cost that constitutes an economic barrier to entry on its own. An ancillary barrier to entry is a cost that does not constitute a barrier to entry by itself, but reinforces other barriers to entry if they are present. [1] [6]

An antitrust barrier to entry is "a cost that delays entry and thereby reduces social welfare relative to immediate but equally costly entry". [1] This contrasts with the concept of economic barrier to entry defined above, as it can delay entry into a market but does not result in any cost-advantage to incumbents in the market. All economic barriers to entry are antitrust barriers to entry, but the converse is not true.

Examples

The following examples fit all the common definitions of primary economic barriers to entry.

Contentious examples

The following examples are sometimes cited as barriers to entry, but don't fit all the commonly cited definitions of a barrier to entry. Many of these fit the definition of antitrust barriers to entry or ancillary economic barriers to entry.

Classification and examples

Michael Porter classifies the markets into four general cases [ citation needed ]:

These markets combine the attributes:

The higher the barriers to entry and exit, the more prone a market tends to be a natural monopoly. The reverse is also true. The lower the barriers, the more likely the market will become perfect competition.

Market structure

  1. Perfect competition: Zero barriers to entry. Due to the perfect competition results in firms are unable to control the prices and produce similar or the same goods, that firms can not form a barrier to entry strategy. [9]
  2. Monopolistic competition: Medium barriers to entry. Because of the enterprises can earn their short-term revenue through innovation and marketing new products to push the price higher than average costs and marginal costs, which can make barriers to entry higher. [10] However, due to the low cost of the information in monopolistic competition, the barrier of entry lower than in oligopoly or monopoly as new entrants come. [11]
  3. Oligopoly: High barriers to entry, due to the size of the existing enterprises and the competitive advantages gained from that size.[ citation needed ]
  4. Monopoly: Very high to absolute barriers to entry. The implementation of monopoly including the exciting firms can obtain tremendous profits through pure monopoly market because they want to continue to earn excess profits in the short and long term. Once they gain these profits, the other entrants want to enter the market due to the huge profit. As a result, the existing monopolies would obstacle to prevents new corporations from the distributors or economies of scales. [12] It can be achieved by creating large economies of scales, patent, trademark, etc.

See also

Related Research Articles

A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity. This contrasts with a monopsony which relates to a single entity's control of a market to purchase a good or service, and with oligopoly and duopoly which consists of a few sellers dominating a market. Monopolies are thus characterized by a lack of economic competition to produce the good or service, a lack of viable substitute goods, and the possibility of a high monopoly price well above the seller's marginal cost that leads to a high monopoly profit. The verb monopolise or monopolize refers to the process by which a company gains the ability to raise prices or exclude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the power to charge overly high prices, which is associated with a decrease in social surplus. Although monopolies may be big businesses, size is not a characteristic of a monopoly. A small business may still have the power to raise prices in a small industry.

Monopolistic competition Imperfect competition of differentiated products that are not perfect substitutes

Monopolistic competition is a type of imperfect competition such that there are many producers competing against each other, but selling products that are differentiated from one another and hence are not perfect substitutes. In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. If this happens in the presence of coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities. The "founding father" of the theory of monopolistic competition is Edward Hastings Chamberlin, who wrote a pioneering book on the subject, Theory of Monopolistic Competition (1933). Joan Robinson published a book The Economics of Imperfect Competition with a comparable theme of distinguishing perfect from imperfect competition. Further work on monopolistic competition was undertaken by Dixit and Stiglitz who created the Dixit-Stiglitz model which has proved applicable used in the sub fields of international trade theory, macroeconomics and economic geography.

Natural monopoly Concept in economics

A natural monopoly is a monopoly in an industry in which high infrastructural costs and other barriers to entry relative to the size of the market give the largest supplier in an industry, often the first supplier in a market, an overwhelming advantage over potential competitors. This frequently occurs in industries where capital costs predominate, creating economies of scale that are large in relation to the size of the market; examples include public utilities such as water services and electricity. Natural monopolies were recognized as potential sources of market failure as early as the 19th century; John Stuart Mill advocated government regulation to make them serve the public good.

An oligopoly is a market form wherein a market or industry is dominated by a small group of large sellers (oligopolists). For example, it has been found that insulin and the electrical industry are highly oligopolist in the US.

In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In theoretical models where conditions of perfect competition hold, it has been demonstrated that a market will reach an equilibrium in which the quantity supplied for every product or service, including labor, equals the quantity demanded at the current price. This equilibrium would be a Pareto optimum.

In economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfil all the necessary conditions of a perfectly competitive market, resulting in market failure.

Porters five forces analysis

Porter's Five Forces Framework is a method of analysing the operating environment of a competition of a business. It draws from industrial organization (IO) economics to derive five forces that determine the competitive intensity and, therefore, the attractiveness of an industry in terms of its profitability. An "unattractive" industry is one in which the effect of these five forces reduces overall profitability. The most unattractive industry would be one approaching "pure competition", in which available profits for all firms are driven to normal profit levels. The five-forces perspective is associated with its originator, Michael E. Porter of Harvard University. This framework was first published in Harvard Business Review in 1979.

Anti-competitive practices are business or government practices that prevent or reduce competition in a market. Anti-trust laws differ among state and federal laws to ensure businesses do not engage in competitive practices that harm other, usually smaller, businesses or consumers. These laws are formed to promote healthy competition within a free market by limiting the abuse of monopoly power. Competition allows companies to compete in order for products and services to improve; promote innovation; and provide more choices for consumers. Some business practices may be pro-competitive, economic methodological tests and empirical legal cases are used to test whether business activity constitutes as anti-competitive behavior.

In economics and business ethics, a coercive monopoly is a firm that is able to raise prices, and make production decisions, without the risk that competition would arise to draw away their customers. A coercive monopoly is not merely a sole supplier of a particular kind of good or service, but it is a monopoly where there is no opportunity to compete with it through means such as price competition, technological or product innovation, or marketing; entry into the field is closed. As a coercive monopoly is securely shielded from the possibility of competition, it is able to make pricing and production decisions with the assurance that no competition will arise. It is a case of a non-contestable market. A coercive monopoly has very few incentives to keep prices low and may deliberately price gouge consumers by curtailing production.

In economics, a monopoly is a firm that lacks any viable competition, and is the sole producer of the industry's product. In a normal competitive situation, no firm can charge a price that is significantly higher than the marginal (economic) cost of producing the product. If any firm doing business within a competitive situation tries to raise prices significantly higher than the marginal cost of producing the product, it will lose all of its customers to either other existing firms that charge lower prices, or to a new firm that will find it profitable to use a lower price to take customers away from the firm charging the higher price. But since the monopoly firm does not have to worry about losing customers to competitors, it can set a monopoly price that is significantly higher than its marginal cost, allowing it to have an economic profit that is significantly higher than the normal profit that is typically found in a perfectly competitive industry. The high economic profit obtained by a monopoly firm is referred to as monopoly profit.

A limit price is a price, or pricing strategy, where products are sold by a supplier at a price low enough to make it unprofitable for other players to enter the market.

In economics, the theory of contestable markets, associated primarily with its 1982 proponent William J. Baumol, held that there are markets served by a small number of firms that are nevertheless characterized by competitive equilibrium because of the existence of potential short-term entrants.

In economics, market power refers to the ability of a firm to influence the price at which it sells a product or service to increase economic profit. In other words, market power occurs if a firm does not face a perfectly elastic demand curve and can set its price (P) above marginal cost (MC) without losing sales. This indicates that the magnitude of market power is associated with the gap between P and MC at a firm's profit maximising level of output. Such propensities contradict perfectly competitive markets, where market participants have no market power, P = MC and firms earn zero economic profit. Market participants in perfectly competitive markets are consequently referred to as 'price takers', whereas market participants that exhibit market power are referred to as 'price makers' or 'price setters'.

Non-price competition

Non-price competition is a marketing strategy "in which one firm tries to distinguish its product or service from competing products on the basis of attributes like design and workmanship". It often occurs in imperfectly competitive markets because it exists between two or more producers that sell goods and services at the same prices but compete to increase their respective market shares through non-price measures such as marketing schemes and greater quality. It is a form of competition that requires firms to focus on product differentiation instead of pricing strategies among competitors. Such differentiation measures allowing for firms to distinguish themselves, and their products from competitors, may include, offering superb quality of service, extensive distribution, customer focus, or any sustainable competitive advantage other than price. When price controls are not present, the set of competitive equilibria naturally correspond to the state of natural outcomes in Hatfield and Milgrom's two-sided matching with contracts model.

Free entry

In economics, free entry is a condition in which firms can freely enter the market for an economic good by establishing production and beginning to sell the product. The assumption of free entry implies that if there are firms earning excessively high profits in a given industry, new firms that also seek a high profit are likely to start to produce or change into a production of the same good to join the market. In such a case there are no barriers preventing a start-up firm from competing. Where an opportunity of a profit arises we assume that there will also be firms entering the market for the certain good and compete for it. In most markets this condition is present only in the long run.

In the theories of competition in economics, strategic entry deterrence is when an existing firm within a market acts in a manner to discourage the entry of new potential firms to the market. These actions create greater barriers to entry for firms seeking entrance to the market and ensure that incumbent firms retain a large portion of market share or market power. Deterring strategies, might include an excess capacity, limit pricing, predatory pricing, predatory acquisition and switching costs. Although in the short run, entry deterring strategies might lead to a firm operating inefficiently, in the long run the firm will have a stronger holder over market conditions.

Market structure

Market structure, in economics, depicts how firms are differentiated and categorised based on the types of goods they sell (homogeneous/heterogeneous) and how their operations are affected by external factors and elements. Market structure makes it easier to understand the characteristics of diverse markets.

Competition (economics) Rivalry between firms; ability of companies to take each others market share in a given market

In economics, competition is a scenario where different economic firms are in contention to obtain goods that are limited by varying the elements of the marketing mix: price, product, promotion and place. In classical economic thought, competition causes commercial firms to develop new products, services and technologies, which would give consumers greater selection and better products. The greater the selection of a good is in the market, prices are typically lower for the products, compared to what the price would be if there was no competition (monopoly) or little competition (oligopoly). This is because there is now no rivalry between firms to obtain the product as there is enough for everyone. The level of competition that exists within the market is dependant on a variety of factors both on the firm/ seller side; the number of firms, barriers to entry, information availability, availability/ accessibility of resources. The number of buyers within the market also factors into competition with each buyer having a willingness to pay, influencing overall demand for the product in the market.

In economics, barriers to exit are obstacles in the path of a firm which wants to leave a given market or industrial sector. These obstacles often cost the firm financially to leave the market and may prohibit it doing so. There are various factors that can affect barriers to exit.

An economic profit is the difference between the revenue a commercial entity has received from its outputs and the opportunity costs of its inputs. Unlike an accounting profit, an economic profit takes into account both a firm's implicit and explicit costs, whereas an accounting profit only relates to the explicit costs which appear on a firm's financial statements. Because it includes additional implicit costs, the economic profit usually differs from the accounting profit.

References

  1. 1 2 3 4 5 6 7 8 "When Are Sunk Costs Barriers to Entry?" (PDF). caltech.edu. Archived (PDF) from the original on 27 March 2016. Retrieved 3 May 2018.
  2. "Antitrust Aspects of Barriers to Entry" (PDF). micronomics.com. Archived (PDF) from the original on 17 May 2017. Retrieved 3 May 2018.
  3. "Competition and Barriers to Entry" (PDF). oecd.org. Archived (PDF) from the original on 29 August 2017. Retrieved 3 May 2018.
  4. "Entry Barriers and Contemporary Antitrust Litigation". Archived from the original on 2016-03-29.
  5. "Archived copy" (PDF). Archived (PDF) from the original on 2009-05-21. Retrieved 2009-12-16.CS1 maint: archived copy as title (link)
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  9. Valence, Gerard de (November 2012). "The Significance of Barriers to Entry in the Construction Industry". Construction Economics and Building. 7: 29–36. doi:10.5130/ajceb.v7i1.2975 . Retrieved 2020-11-01.
  10. Boland, Michael A.; Crespi, John M.; Silva, Jena; Xia, Tian; Boland, Michael A.; Crespi, John M.; Silva, Jena; Xia, Tian (2012). "Measuring the Benefits to Advertising under Monopolistic Competition". Journal of Agricultural and Resource Economics. doi:10.22004/ag.econ.122308 . Retrieved 2020-11-01.
  11. Todorova, Tamara (2016). "Some Efficiency Aspects of Monopolistic Competition: Innovation, Variety and Transaction Costs".Cite journal requires |journal= (help)
  12. Dilek, Serkan; Top, Seyfi (2012-10-12). "Is Setting up Barriers to Entry Always Profitable for Incumbent Firms?". Procedia - Social and Behavioral Sciences. 8th International Strategic Management Conference. 58: 774–782. doi:10.1016/j.sbspro.2012.09.1055. ISSN   1877-0428.