This paper examines how barriers to entry arise from both natural market forces and deliberate incumbent strategy to sustain long-run equilibrium in monopolistic markets. It begins by defining marginal equilibrium under neoclassical economics, then identifies key barrier types—including government-enforced protections such as copyright, network dominance exemplified by Microsoft, excess capacity, sunk costs, and limit pricing—explaining how each deters potential entrants. The paper also considers psychological deterrence effects and barriers to exit. Throughout, it argues that monopolistic organizations benefit enormously from maintaining these barriers, as equilibrium in such markets preserves above-normal profits that competitive entry would erode.
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, 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. 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, 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 in 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 those units will generate, meaning no net gain and no additional profit (Baumol & Blinder, 2008).
Under the neoclassical theory of economics, the state at which marginal costs are equal to marginal revenues is known as market equilibrium. Increases in supply through the production of even one more unit cause a price shift that eliminates any profits generated from that production, and/or production costs to produce a single extra unit are equal to the revenue that can be generated at the current price; 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.
There are many different kinds of market barriers, including different types of barriers to entry as well as barriers to exiting a market. All of these help to establish a market equilibrium by quickly winnowing down a market to its viable players and 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 — is in their best interest.
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 a Windows 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 or owner enables higher pricing structures and larger profits for the owners of this property than would be achievable under normal market circumstances (Bernanke, 2003). Both of these barriers to entry essentially allow — and are perhaps the result of — monopolistic control of an industry, permitting 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 negative outcome in the long term, yet it 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 those markets, maintain equilibrium losses in certain industries and markets (Bernanke, 2003). Other strategic barriers, such as predatory pricing and other deliberate strategic moves, can also create barriers to entry (McNutt, 2008).
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 logically advantageous for potential market entrants to avoid that entry altogether (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 there to be the appearance of a likely pricing war, which would dissuade new entrants from 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 when, either as the result of technological developments or sudden reductions in demand, companies in a given market find themselves with 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. Thus, excess capacity in incumbent organizations can itself function as a barrier to market entry (McNutt, 2008). In both of these examples, the very threat of a change in equilibrium is 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 it leads to an actual excess in capacity — could also be used as a potential entry barrier. 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 for incumbents due to these sunk costs than new entry would be for an outsider. 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 those sunk costs (Arping & Dlaw, 2007). 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).
"Profit preservation and psychological deterrence effects"
Maintaining equilibrium is rarely advisable and even more rarely possible in a competitive market. In monopolized markets and industries, however, maintaining equilibrium is both possible and usually highly advantageous to the monopolistic organization. Establishing strategic barriers to market entry — often occurring naturally through the dominance of the given industry or market — is a necessary element in maintaining this equilibrium, as introducing competition to the market would necessarily alter the equilibrium, and never in the monopoly's favor (McNutt, 2008). The barriers discussed above are quite effective in this regard.
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