Micro Chapter 11 Price-Searcher Markets with High Entry Barriers

6 Learning Goals 1)Name the reasons why entry barriers can be high 2)Characterize and explain the output decisions of a monopoly firm 3)Identify the characteristics of an oligopoly market 4)Explain the output decisions of an oligopoly firm 5)List the problems caused by high entry barriers 6)Consider government policies that can counteract the problems caused by high entry barriers

Why are Entry Barriers Sometimes High?

An entry barrier is something that prevents you from opening a business in a particular industry Preventions: (1) Sometimes you just need to start as a really big firm (2) Another firm may have a license or patent that precludes you (3) Somebody else owns the vital resource

Entry barriers create market power If no new firms can enter the market to steal customers and profits, the existing firms behave differently

Characteristics of Monopoly

A true case of monopoly is actually rare No substitute product is a requirement

Similar to monopolistic competition, the firm now decides price and output The firm is the market (i.e. market demand curve = firm demand curve) Continue to produce as long as MR > MC

Price Quantity/time d P MR q MC ATC C B A and price P (along the demand curve) will be charged. Price and Output Under Monopoly The monopolist will reduce price and expand output as long as MR > MC. MR > MC MR < MC The monopolist will raise price and reduce output whenever MR < MC. Output level q will result … At output q the average total cost is C. As P > C (price > ATC) the firm is making economic profits equal to the area PABC. Economic profits

If there is no substitute, why not set price at $1 million? The firm will set price according to market demand (i.e. willingness to pay) In the SR the firm can earn positive economic profit

Will LR profits be pushed to zero? No, because of entry barriers No new firm can enter and take profit away

Is the monopolist guaranteed SR and LR profit? SR and LR profit can be positive, negative, or zero

The Characteristics of an Oligopoly

The key characteristic is interdependence among firms which leads to strategic behavior

Game theory is often used to analyze oligopolies John Nash won the Nobel prize in economics for his pioneering work that was later used in this area

Recall the other 3 industries: A perfectly competitive firm is not concerned about any other firm A monopolist doesn’t have another firm to consider A monopolistically competitive firm is only somewhat concerned about what other firms are doing

An oligopoly firm is greatly concerned about what the other firms in the industry are doing Each firm will base part of its own decisions on what they think other firms are doing or will do

Price and Output under Oligopoly

Each analysis really becomes a case-study because: Sometimes oligopolists will act like perfectly competitive firms Sometimes they’ll act like monopolists Many times they switch between the two (act one way for awhile then another)

Ceteris paribus, what would make a firm better off? A higher price for its product How could this be achieved? If output were kept low, price would generally rise Would one firm voluntarily or even have an incentive to keep output low? Probably not because the other firms would increase production, lower price, and steal customers

What if the firms jointly agreed to keep production low? This would generally be good for all firms But the incentive to cheat would be so great that the agreement probably wouldn’t last long

Defects of Markets with High Entry Barriers

Generally, the outcomes of monopoly and oligopoly are not as desirable as with perfect competition Output is lower Price is higher Some gains from trade are not realized Variety is lower

Policy Alternatives When Entry Barriers are High

Four options to “fix” the industry: 1)Antitrust Policy (Sherman Act, Clayton Act, FTC, etc) 2)Reduce artificial barriers 3)Regulate price and output 4)Government production