Influence of High Entry Barriers to the Market Structure

Subject: Economics
Type: Expository Essay
Pages: 9
Word count: 2402
Topics: Macroeconomics, Microeconomics

Effects of High Entry Barriers into a Market on:

a)      Long-run Profitability of the Firms

Entry barriers to an industry can be defined as anything that hinders entry and reduces effectively the level of competition in the market (Gans, 2003).These barriers are mainly in the form of government restrictions such as licensing, special tax incentives to existing firms, and the market policies which make entry cumbersome. Patents give firms legal rights to supply new products to the market and advance the invention for a specified period of time depending on the agreement. Economies of scale, on the other hand, disadvantage new market entrants as large firms are in a position make mass production thus lowering the Average Cost (AC). Furthermore, large companies can lower the price of their products without much financial implication. This makes entrant firms lose their market share and thus unable operate in such market conditions.

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High levels of barriers, therefore, result in the rise of a monopolistic market (Goodwin, 2009). A purely monopolistic firm is the sole seller of a given product in the market and the product doesn’t have an ideal substitute. Monopolistic firms are therefore protected from direct competition from their competitors which are focusing on the same products. Hypothetically, monopolistic firms have the ability to produce an effective product but the output of this market structure does not meet fully the need of people within the economy. This gives them the freedom to manipulate the market prices by influencing the product supply. For the monopolistic firms to maximize profits, they have to produce the output where the Marginal Revenue (MR) equals Marginal Cost (MC). Monopolist firms enjoy long-run economic profits as compared to firms that are in a competitive market.

b) Cost Efficiency of the Firms in the Industry

 Cost fluctuations play an important role in determining the ability of firms to survive in a given market. Economies of scale take place when cost units decrease as production output or volume increase. A firm’s Fixed Costs (FC) and Marginal Costs (MC) determines the survivability of the firm. The firms in the market with an increased level of production are forced to reduce the Average Total Costs (ATC) (Scherer & Ross, 1990) so as to be able to survive and at the same time make considerable profits. Companies and firms are required to be comfortable at the minimum average profits which enables them to be operational in long term. On the other hand, the short-term operation of firms is attributed to the ability of the firm to meet the Operational Cost (OC) and Fixed Cost (FC) efficiently. Economies of scale make it easy for the available firms to manage the cost of the products. This is applicable mostly to big firms by enabling them to cut down their prices. It is, therefore, essential for firms which are less endowed with resources to form alliances and joint ventures so as to be able to deal with the barriers effectively and reduce risk associated with sole operations.

c) The likelihood that some Inefficient Firms will survive

 The likelihood inefficient firms in the market surviving is minimal as compared to when the entry barriers are meager. However, high entry barriers motivate the new market entrants to embrace the use of technology, innovations, and conduction of market surveying to come up with quality and superior substitutes. The Firms that get into the market with quality goods and services will lead to the eradication of inefficient firms completely.

d)     The incentive of Entrepreneurs to Develop Substitutes for the Product Supplied by the Firms

High barriers to entry also occur in markets where some firms possess ownership of resources that have no alternative. For instance, a firm may be owning the sole supply of the raw materials that are key in the manufacture of a product. This will impede new entrance to the market unless alternative raw materials are discovered or invented which does not augur well with the existing raw material. The demand for substitutes acts as a pivotal incentive for entrepreneurs in coming up with alternatives. In addition, there are market rights that permit monopolistic firms to motivate entrepreneurs to be more innovative in the goods they produce and also come up with cheap production methods.

2. Are Competitive Pressures Present in Markets with high Barriers to Entry? Explain.

There are Competitive pressures in markets with high barriers to entry (Foster, 2006).This is due to the fact that all products have substitutes. In monopolistic markets, firms may raise their prices and this will encourage other firms to come up with substitutes, this will limit the market power of monopolists. Barriers such as restriction initiated by the law organs and rights granted to operate the business lead to the introduction of new ideas and eventually, alternative products are created. Entrepreneurs which aims at providing better products and lowering their cost of production are able to offer competition to monopolistic firms.

The oligopoly market structures have very high barriers to entry and have competitive pressures. Oligopoly is a market structure comprising of small buyers and sellers only. Firms in this type of market structure are immense and are interconnected so that in case the sellers want to set the price of their product they have to put into consideration the perception of their competitors. The competitive pressure in oligopoly market is quite higher as the price decision of one seller has an impact on the real price of the product, productivity, and the overall benefits of the competitors in the same market.

3. Describe which market structure you would prefer for selling products. Explain why and support your answer with the characteristics of that market.

A monopoly market structure is preferable for selling products. The monopoly is a type of market structure with a high level of entry barriers hence restriction of other firms from entering the market is applicable. The sellers in the market are sole with no substitute. The existing firm has the power to influence the price of the product through manipulation of the supply in the market. This market structure enables a firm to enjoy higher profits both in the short run and long run.

The existence of a single seller makes the demand curve act as monopolist firms demand curve. This makes the firm to neglect the price of their competitor. The firm in this market structure will continue selling as long as the marginal cost is greater than marginal revenue.

4. Describe which market structure you would prefer for buying products. Explain why and support your answer with the characteristics of that market.

Perfect competition market is ideal for buying a product. In this market structure, there are various sellers dealing with the same goods. Due to the presence of many sellers individual firm cannot dictate the price of a commodity. The buyers have added advantage because the prices are greatly regulated by the demand and supply forces. The sellers and the final consumers have a comprehensive information regarding the product and this diminishes exploitation of consumer. 

5. How does each market structure respond to price changes of the products that they sell? Explain whether each market structure will be selling elastic or inelastic products, and how this will affect the market price.

A single firm in a monopolistic market is in a position to dictate the price of a product as it solely controls the supply of the product in the market. The curve of the market demand is the monopolist firm’s demand curve. The nature of the demand curve is always sloping downwards. In order to attain maximum profit realization firm needs to improve the output so that the MR to be equal to MC. The price of the goods will be based on the demand curve which has high consistency level to the output.

 In monopoly markets, a single firm is able to set a product’s price to its benefit. This is because they control the entire market supply of a particular product or service. Therefore, the market demand curve is the monopolist firm’s demand curve. The demand curve, in this case, slopes downwards. To maximize profit, a monopolist firm will increase its output so that its marginal revenue equals its marginal cost. The price will be charged along the demand curve which is consistent with the current level of output. When MR is greater than MC, the firm lowers the prices and increase output. When MR is less than MC, the firm increases the price and lowers the output. Monopoly deals with both elastic and inelastic goods but elastic goods dominate the market as compared to inelastic goods. The reason behind it is that there are no alternative goods for consumers.

Perfect competition market is a market structure with the large volume of sellers. The decision of the firm in this market on the productivity does not have any impact on the market price. Therefore, the output price is the same as the marginal revenue. The marginal revenue and the marginal cost are used to show if the firm will continue at the same production level or not. Maximum profit is achieved when the marginal revenue exceeds the marginal cost, the firm thus needs to increase the output. 

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A perfectly competitive market has an elastic demand as it is the only market structure which takes the price (price taker).Increase in price result to decrease in the total revenue and a decrease in price result in a higher total revenue. The price in perfect competition is based on the equilibrium because the price of goods and the profit are interconnected with the competing firms.

An oligopoly market structure comprises of small rival firms dealing with the same but differentiated goods. Firms in the oligopoly are interconnected and their prices rely on the prices of the rivals. This concept enables different firms to form alliances to increase prices. The demand curve in this market structure is kinked having two separate lines with different slopes. Maximum profit is attained when the marginal revenue is equal to marginal cost. In an oligopoly, there is no certain theory which gives a guideline on prices and the output due to the over-reliance of the firms on each other action in terms of price changes.

Monopolistic competition is defined as the market structure with both many buyers and seller but the goods are fully differentiated. The product differentiation enables the firms to have control over the prices. The demand curve in this market structure is elastic in some price range and inelastic in the lower price level. Profit is maximum at the point where the marginal cost is the same as marginal revenue.

6. How does the role of the government affect each market structure’s ability to price their product?

Government restrictions in a monopolistic market is a barrier to entry into the market. These restrictions include but not limited to issuance of the license, patent rights, quotas and tariffs, and regulation on the suppliers to the market. The government grants permission to certain firms so as to be able to carry out their business which is bureaucratic and costly for new competitors. The firms in the market are granted the right to use the new technology and innovations to shy away from their competitors. Government restrictions permit the monopoly firms to take over control of the prices (Feenstra, 2004).

Oligopoly market allows firms to come together and determine the price of their good. This is due to the presence of few firms which are interrelated. When a firm increases its prices and become the market leader, it will dictate their counterparts. This thus necessitate a merger between various firms so as to come up with a common price and make maximum profit. 

The oligopoly market has merger firms which are correlated. Firms in this market structure can collaborate and decide how much to charge on their goods jointly. When a firm in the market establishes itself as a market leader by raising the price of the product it will dictate the price of the product in the market. The dictated price will automatically become the real price of the product and firms in the market can collaborate to increase their profit margins. There are several ways in which firms can form a collaboration including the price fixation, dividing the markets, and bid rigging. However, these collaborations are prohibited by the government.

The role played by the supply and demand curves in a perfect competition market is to indicate the price of the goods and services that buyers and sellers are unable to determine. This market structure has little barriers and the government doesn’t interfere with the price.

Due to the presence of the many firms in a monopolistic competition, firms can control the price by coming up with their prices without considering the prices of their competitors (Colander, 2008). The policies of the government safeguard consumers from exploitation and remove firms which are inefficient in the market.

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7. How does international trade affect each market structure?

There are no barriers to enter the market in perfect competition and monopolistic competition markets (Sloman, 2009). Competing firms are able to enter or exit the market freely.

On the other hand, monopoly and oligopoly have very high barriers to entry of new players in the market. The barriers include quotas and tariffs. Many countries use import quotas and tariffs to maintain the price of the local goods. Tariffs are used to discourage consumers from buying the imported goods while quotas are used to limit the imported products so that the local goods are promoted.

The effect of tariffs relies on the elasticity of demand and supply. When the demand and supply are elastic then tariff have great impact. Little effects on the imports are experienced when the demand and supply are inelastic. Tariffs and quotas can lead to a trade war between countries. However, this will raise the cost of conducting business for the exporting firms and sometimes can lead to low-quality products. Tariffs and quotas affect consumers in most cases and cause benefits to foreign and local producers who stand to get higher prices (Davies & Cline, 2005).

International trade widens the option that a consumer can choose from thus lowering the price of the goods. International trade also enables the consumer to increase their purchasing powers, ensures both consumers and sellers have information and lowering the price of commodities.

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  2. Davies A. & Cline T. (2005). A Consumer Behavior Approach to Modeling Monopolistic Competition. Journal of Economic Psychology 26 (6): 797–826
  3. Feenstra R.C. (2004). Advanced international trade: Theory and evidence. Princeton: Princeton University Press
  4. Foster L., Haltiwanger J & Krizan J. (2006). Market selection, real-location, and restructuring in the U.S. retail trade sector in the 1990s. Review of Economics and Statistics 88, 748–758
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