Equilibrium and Barriers to Entry and Long-Term Essay

Excerpt from Essay :

Equilibrium and Barriers

Barriers to Entry and Long-Term Equilibrium in Monopolistic Markets: Strategy and Market Forces

Introduction Marginal Equilibrium

Barriers to entry can arise out of natural market forces as well as through careful strategic creation or enhancement by incumbent organizations that have a great deal of control over a given market and/or industry. When a specific organization has established a monopolistic or near-monopolistic control over its market and enjoys a great deal of stability and equilibrium with some price flexibility as well, it can be very much in its interest to erect or encourage barriers to entry that thwart the possibility of other entrants into the market, disrupting this equilibrium. As mentioned, many of these barriers to entry arise on their own out of market forces, but they can also be encouraged by strategic decisions within incumbent organizations that influence the market generally and at times explicitly.

Before examining how these barriers can be achieved and strategically employed, however, an understanding of how equilibrium is achieved is necessary. Assuming that supply and demand in a given market remain on a constant curve -- which generally also implies a constant price structure and is only achievable n practice when competition is limited -- a firm will reach a state of marginal equilibrium, where marginal costs are equal to marginal revenues (Baumol & Blinder 2008). That is, the organization will reach a production level at which the added cost of producing additional units -- the marginal cost of a given number of units -- is equal to the additional revenue that the sale of these units will generate, meaning no net gain -- no profit (Baumol & Blinder 2008).

Under the neo-classical theory of economics, the state at which marginal costs are equal to marginal revenues is known as market equilibrium; increases in supply by the production of even one more unit cause a price shift that eliminates any profits generated form that production, and/or production costs to produce a single extra unit are equal to the revenue that can be generated at a current price, and a change in price would create a shift in the overall supply-demand curve (Baumol & Blinder 2008). Thus, without producing this extra, non-profit-generating unit, the company has achieved its profit maximization and expends no unnecessary energy, time, or resources on activities that do not generate profits. This state of equilibrium is ideal for most companies, but is achievable only in situations of long-term equilibrium, and these can be sustained by the strategic introduction and enhancement of barriers to entry that keep other firms from introducing market-changing competition.

Market Barriers and Equilibrium

There are many different kinds of market barriers, including different types of barriers to entry as well as barriers to exiting a market, and these all help to establish a market equilibrium by quickly winnowing down a market to its viable players and quickly establishing pricing levels given relatively fixed terms within the market (Bernanke 2003). When a company benefits from a complete long-run market equilibrium, as do monopolistic corporations in their enterprises, maintaining barriers to both entry and exit (which can often become one and the same thing, as shall be explained) is in their best interests.

Microsoft is one key example of how barriers to entry help to maintain equilibrium. With (as of 2003) ninety-percent of all desktop computers sold in the world running on a Windos operating system, Microsoft's market dominance was a major barrier to entry in and of itself (Bernanke 2003). Microsoft was -- and is -- able to control the price of its products and retain higher than normal profits in a state of basic equilibrium because it is so difficult for new entrants to gain any sizeable market share. The publishing world and indeed all industries involving intellectual property benefit from barriers to entry that are government-enforced: copyrights (Bernanke 2003). Making the reproduction of intellectual property illegal except by the consent of the creator/owner enables higher pricing structures and larger profits for the owners of this property than would be achievable under normal market circumstances (Bernanke 2003). Again, both of these barriers to entry essentially allow (and are perhaps the result of) monopolistic control of an industry, allowing a market equilibrium to be reached at a much higher price-point than would have been achieved in a competitive market.

When there is not a monopolistic organization operating in a given market, equilibrium is often a bad thing n the long-term yet is also held in place by market barriers. Barriers to exit, such as government regulations ensuring that specific markets are served by airline carriers even when carriers lose money in these markets, maintain the equilibrium losses in certain industries/markets (Bernanke 2003). Other strategic barriers such as predatory pricing and other deliberate strategic moves can also create barriers to entry (McNutt 2008).

Strategic Barriers to Entry

Price wars can be used as a major barrier to entry by large incumbent organizations; the threat of a price-cutting war that the large incumbent will undoubtedly win often makes it in the logical best interests for potential entrants to a market avoid that entry (McNutt 2008). At the same time, such a price war is often disadvantageous to the incumbent company, as well, and will lead to greater losses in both short- and long-term profitability than would accommodating the new entrant (McNutt 2008). This "limit pricing model" thus suggests that it is more advantageous for their to be the appearance of a likely pricing war, which would dissuade new entrants form attempting anything and allow the incumbent organization to sidestep any potential losses to profitability (McNutt 2008).

Predatory pricing strategies such as this can also be used in times when, either as the result of technological developments or sudden reductions in demand, companies in a given market find themselves with an excess capacity (McNutt 2008). Excess capacity also serves to make threats of predatory pricing more credible, as the production of more units without significant increases in marginal costs can maintain decent revenue rates even while dropping the consumer price per unit, and thus excess capacity in incumbent organizations can actually be a barrier to market entry in and of itself (McNutt 2008). In both of these examples, the very threat of a change in equilibrium is actually enough to potentially thwart new entrants to a given market or industry based on fears of incumbent reactions (McNutt 2008).

From this last example, it is clear that purposeful capacity expansion -- whether or not this leads to an actual excess in capacity -- could also be used as a potential entry barrier for new entrants to a market or industry. Sunk costs that have already been expended are often a major part of incumbent investment in a given market and/or industry, and expansion is often cheaper due to these sunk costs than new entry; this makes incumbents far less likely to accommodate new entrants by selling assets and limiting market share when they have less to lose by simply expanding and capitalizing on these sunk costs (Arping & Dlaw 2007). The knowledge of a large amount of sunk costs and the increased attractiveness of capacity expansion can, like the threat of predatory pricing, serve as a deterrent to market entry due to fears that entry will result in a clear incumbent victory and the complete or near complete elimination of the new entrant (Arping & Dlaw 2007).

Benefits of Entry-Deterring Strategies

There are actually many benefits to competition in certain industries, but other markets and their dominance by a single monopolistic organizations make entry barriers highly beneficial to these companies. Profit potential is obviously much higher for monopolies than it is for duopolies or situations with larger numbers of competitors; in competition, prices find their natural lows as consumers bid them…

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