6 BARRIERS TO ENTRY ( AND HOW THEY ACT AS SOURCE OF MARKET POWER)

The existence of a large barrier to entry is an important source of market power for an imperfectly competitive firm. 

The existence of these barriers differentiates a monopoly and oligopoly from other marker structures.

Barriers to entry are legal, technological obstacles, or restrictions that prevent potential competitors from entering a market. 

Barriers to entry can also be defined as laws, institutions, practices and technologies which make it difficult or impossible for new firms to enter a market.

The existence of a barrier of entry gives the incumbent firm some form of market power in that they can make pricing decisions without the risk of losing market share.

This barrier of entry may range from easy and surmountable ones to highly insurmountable barriers.

Barriers to entry include the following:

1. Exclusive control over essential resources

2. Economics of scale

3. Predator pricing

4. High fixed cost

5. Large advertising budget and dominant brand name.

6. Legal barriers 

Exclusive control over essential resources

New firms could be barred from entering a market if the existing firms have some exclusive control over resources needed to operate in an industry.

When a firm has exclusive control over essential resources, it can raise prices without losing market share as no competing firm can access the resources needed to create substitute goods for its product.

Economies of scale

This is yet another barrier to entry and source of market power. 

Economies of scale are the cost advantage that large firms gains as they increase output. 

Economies of scale are a barrier to entry, particularly for industries that require large-scale production.

This is because the economies of scale allow existing firms to lower costs than those just starting production.

And considering business risk, this may discourage new entrants into the market. 

Moreover, the economies of scale are, by definition, a major factor for natural monopoly and predatory pricing.

Predatory pricing

This is arguably the most vicious barrier to entry that can be erected by an oligopoly as well as a monopolist.

Predatory pricing occurs when existing firms industry-low low prices to deter the new firms from entering the market. 

Predatory pricing occurs when existing firms cut prices sharply to deter competition and intimidate competitors.

In predatory pricing, firms reduce prices to discourage new entrants. After the possibility of a new entrant has been eliminated, the existing firm would raise the price again.

Predatory pricing deters new firms, albeit the existing firm would not maximize profit

Predatory pricing will, however, be only effective if the existing firm in the market can increase output so that the competing firm would not make an impact in the market. 

In most countries, predatory pricing is illegal. However, predatory pricing has continued to strive in most industries, as it is difficult, if not, impossible to prove.

High fixed cost

Total cost, as I said before, is made up o fixed costs and variable costs.

Fixed cost is a cost that is independent of output. They are usually overhead costs.

Some industries (like the aviation industry, and space transport) require fixed contests.

Research and Development costs represent a large percentage of total costs in industries. Only a few firms will be able to make this initial investment. This acts as a barrier to entry.

Large advertising budget and dominant brand name

A large advertising budget by an existing firm could make market entry difficult for a new firm.

This is especially true for industries where the only way to succeed is to promote your product aggressively.

Perhaps, this explains why Pepsi and coca-cola still spend millions of dollars on advertising despite having a lot of loyal consumers.

As research has shown, advertising does not just increase the firm's demand, it also helps reduce the price elasticity of demand for its product. 

Advertising could also make consumers believe there is no close substitute for a product even if there is.

This increases consumer loyalty to a brand. 

And you know what? when firms have numerous consumer loyalist, they could affect price changes, at least–as the demand curve permit them, knowing fully well that consumer does not view competitors' goods as a viable substitute. 

Consequently, this acts as a barrier to entry as the potential new entrant may decide that it is not reasonable to compete with firmly-established brands.

Legal barriers

Sometimes, the government may grant exclusive licenses to producers for the sole aim of promoting innovation. 

Granting this exclusive right to the supplier, by definition, would bar new entry into an industry, ultimately cancelling every possibility of competition

Moreover, these legal barriers help supplier monopolize their goods easily. Below are some examples of legal barriers that may lead to a monopoly.

1. Copyright: If you have been reading books or other creative works, the term "copyright" would not be new to you. Below is an example of a copyright notice.


Copyright is some sort of legal concept that gives the owner of a creative work the exclusive right to determine who may copy, publish, and benefit financially from his works. 

Copyright is automatically granted to the owner of a creative work immediately after he produces his work. He may not register for copyright.

Copyright prevents creative works from being copied without the prior permission of the owner.

As long as it exists, it deterred competition from other firms. The owner of the copyright can sell at whatever price he wants knowing fully well that no one can legally trade his product without his permission.

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2. Patent:  This is a limited exclusive property right given to an inventor of creative work in exchange for an agreement to share details of his work with the public.

During the patent period, inventors can choose who used their inventions and who benefits financially. 

This allows inventors to recoup their research and development costs which would not be possible if the goods are unpatented.

Once the patent expires, another firm can build on the inventor's works to create theirs. The idea of the patent is that it grants the inventor's monopoly power over their product for a limited period so he would recover his research and development cost in exchange for the details of his work.

Taken together, both patient and copyright are called intellectual property. Intellectual property refers to anything of someone's intellect(idea), rather than a physical object, which has commercial value and is backed by law.

Conclusion

Barriers to entry are very important features of imperfect competition.

The market would be dominated by few firms if there are barriers to entry.

The concept of the barrier of entry is fundamental in understanding the models of oligopoly and monopoly.

over to you now...

Do you think a firm will enter a market even with a barrier to entry in place?. Tell me in the comment box.

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