Barriers to entry
A barrier to entry is a condition that precludes firms from entering and industry to compete for profits. Barriers exist when new firms find it difficult to enter the market. If such barriers exist the elasticity of supply will be less that if no such barriers existed. Barriers that prevent such firms form entering a monopoly industry include economies of scale, government licensing, penitents, and exclusive control over an important resource.
Economies of scale
Suppose that five firms currently that share a market and that each sells 100 units of output at a break even price of £10 per unit. If new technology was developed enabling a single firm to produce 500 units of output at a price of £5 per unit. One of the firms would take advantage of this technology and use it to up the other four firms out of business. Monopolies that arise for the economy of scale are often called natural monopolies.
Natural Monopolies
a natural monopoly is having vast scale of economies, firms that arise from the economy of scale do not have any fear of smaller competitors entering the industry.
Government licensing
Government licensing constitute legal barriers to entry, most legal barriers limit the number of competitors, but do not result in a single pure monopoly firm. For example many states require hospitals and nursing homes to file a Certificate of Need to obtain permission to expand. Such laws are designed to prevent unnecessary duplication of services, but they also result in reduction of the number of hospitals. Many state governments require licenses for alcohol shops, barbershops, funeral parlours and other establishments. Why do legal barriers to entry exist in these industries? Ostensibly, these barriers exist to protect the public – you wouldn’t want you heir cut by just anyone but a trained professional. Barriers to entry often serve businesses more than the public. Requiring the licences reduce the number of competitors and increase the monopoly power of firms within the industry. Government authorisation is needed to engage in business. To obtain a licence, various requirements must be met, and the number of licences is often restricted.
Patents
Patents are a kind of government licensing. In the US, patents grant the owner exclusive production rights - pure monopoly status – for 17 years. Once a patent is granted the owner has exclusive rights to use a process or manufacture a product; other people must apply for permission. The benefit to the investor is 17 years of monopoly profits to recover the investment. Society as a whole also benefits to the extent that patient laws encourage innovation. The cost to the customers is that with out competition, the monopolist is likely to charge a higher price and produce a lower quality.
Control over an important resource
A monopoly can arise if a single firm has the control exclusive control over a resource that is needed by the industry. For example before the 2nd World War, the Aluminium Company of America (ALCOA) had almost complete control of the worlds knows supply of bauxite, one of the most important ingredients in aluminium. Although this could not last for ever. ALCOA is still one of the major players in the world aluminium market, but new finds of bauxite after the 2nd World War has shifted the world market form a monopoly to an oligopoly. In our days the competition in the aluminium industry comes form recycling and even ALCOA is involved in recycling.
What is a normal profit?
What is normal profit? Like so many concepts in economics, the answer is “it depends” because we can’t say 5% or £500. Many economists define normal profit as just sufficient profit for the firm to stay in business at its current scale of operation but not expand. Another definition of normal profit is the opportunity cost of investment; that is, the rate of return on the best forgone investment alternative. For example if a firm is making 5% profit, but it could have made 10% by investing in another operation, it is making less than normal profit and it should invest its money elsewhere.
What is a supernormal profit?
Profits above and beyond normal profits are called economic or supernormal profits. Economic profits consist of the surplus of the firms’ revenues over the cost of production, including opportunity cost. Some economists would define economic profits as profits great enough to allow the firm to expand; however, the existence of supernormal profits does not necessarily mean that the firm will expand, so this definition must be used carefully. Supernormal profits are profits that are greater than the rate necessary to maintain the established level of production.
Conclusion
Spontaneous monopolies may abuse their fortunate position in order to make high profits and sell their products at higher prices to achieve those high profits. A firm in a monopoly position may charge the customers a high price for a product with low quality. A famous example comes form the United Stated with Microsoft having a monopoly of 85% in the software industry.
Bibliography
Modern Economics Sixth Edition by Jack Harvey
Principles of Economics by William S. Brown
Introductory Economics, a first approach to the study of economics by Mike Cunningham 1994
Foundations of Economics Second Edition by David Begg, Stanley Fischer, Rudiger Dornbusch
