Managerial Economics Exam questions

Topics: Economics, Supply and demand, Microeconomics Pages: 22 (7392 words) Published: November 13, 2013
Barriers to entry:
In theories of competition in economics, barriers to entry are the obstacles and hindrances that make it difficult for a company to enter a given market or industry. The most common barriers to entry include government regulation and economies of scale, but nowadays it is increasing for entry barriers to be viewed as a cost. Stigler defined barriers to entry 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”. Therefore, these invisible shields protect incumbent firms and reduce competition within the market, which can often lead to market power and the existence of a monopoly. Barriers to entry are one of the key aspects in Porter's five forces analysis, which is a framework for industry analysis and business strategy development based on the competitive intensity and therefore attractiveness of a market. Different barriers will effect companies in different ways, to understand their impacts they are grouped into 3 categories known as consumer preference barriers, absolute cost advantages and scale economies. Preference and cost advantage barriers are present if established firms have lower average unit costs than potential entrants at any given output level. This makes entry expensive for entrants as they have to spend more on advertising and research and development in order to try and create a competitive advantage. To overcome absolute cost advantages entrants have to pay higher prices for inputs, this may be due to economies of scale or due to existing firms owning or controlling the supply of scarce resources. Scale economy barriers exist when declining LRAC for the product in question makes it difficult for smaller firm to enter the market.

Perfectly competitive markets are said to have 0, or low, barriers to entry compared to monopoly industries which have very high barriers. It is possible for monopolies to own patents and intellectual property that give a firm the legal right to stop other firms producing a product for a given period of time, and so restrict entry into a market. Monopolies also have an established relationship with customers within the industry, making it hard for new entries to tease consumers away from this brand loyalty. This is true in the telecommunications industry which is run by a few giant companies like Vodafone and Orange. It would be very hard for a new company to attract customers away as long term contracts are signed which, provide switching barriers, and economies of scale help them maintain low prices. If these economies of scale are substantial, the industry may not be able to support more than one producer. Line D1 represents the industry demand curve and supernormal profits can be gained between points A and B. However if there were 2 firms each producing half the output and charging the same price, they would each face the demand curve D2 which means they would not be able to cover costs. This is known as a natural monopoly.

An example is two bus companies running the same routes, but half full buses makes business un- profitable compared to if there was one company running the routes with full buses. One tool companies companies can use to inhibit other firms entering the market is limit pricing. This is where a monopolist charges a price below the short run profit maximizing level to deliberately restrict it’s the size of its profits so as to not attract new entrants. Lowering of price will also restrict new entrants from competing in terms of price and increasing the number of customers the monopoly retains due to lower prices.

In other industries, markets with monopolistic competition tend to have low barriers to entry, whereas oligopolies,are normally surrounded by slightly higher barriers. In some cases, governments have reduced barriers to entry into these industries, but high sunk costs have discouraged entry. These costs cannot be...
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