A patent is a limited property right the government gives inventors in exchange for their agreement to share the details of their invention with the public. Intellectual property laws are intended to promote innovation, but some economists, such as Milton Friedman, have argued that such laws are not desirable. If the second firm attempts to enter the market at a larger size, like 8,000 planes per year, then it could produce at a lower average cost—but it could not sell all 8,000 planes that it produced because of insufficient demand in the market. Copyright protection ordinarily lasts for the life of the author plus 70 years. Intellectual property – Patents, trademarks, service marks, and other types of proprietary intellectual property are very effective in limiting industry entry. After the patent expires, any pharmaceutical company can manufacture and sell a generic version of the drug, bringing down the price of the original drug to compete with new versions. In 2015, the Justice Department ruled against American Express and Mastercard for imposing restrictions on retailers that encouraged customers to use lower swipe fees on credit transactions. While other word processing programs may be available, an individual would risk running into compatibility problems when sending files to people or machines using the mainstream software. Suppose the local electrical utility, a legal monopoly based on economies of scale, was split into four firms of equal size, with the idea that eliminating the monopoly would promote competitive pricing of electricity. The spread of popularity of the telephone in the 20th Century, and more recently the increased popularity of social media, are example of strong network effects. Distinguish between a natural monopoly and a legal monopoly. There are relatively insignificant barriers to entry or exit, and success invites new competitors into the industry. The same thing happened to local service, especially in recent years, with the growth in cellular phone systems. Barriers to entry are the economic hurdles that a new entrant in the market faces to enter that market, in other words, they are the fixed costs that new entrants have to pay irrespective of production or sales that would otherwise have not been incurred had the participant not been a new entrant. Natural monopolies occur when a single firm can serve the entire market at a lower cost than a combination of two or more firms. usually, the company which is the pioneer in that market controls the resources. Firms gain monopolistic power as a result of markets’ barriers to entry, which discourage potential competitors. The intent behind copyright is to promote the creation of new works by providing creators the opportunity to profit from their works. Single ownership over a resource gives the owner of the resource the power to raise the market price of a good over marginal cost without losing customers to competitors. Y2 10) Barriers to Entry and Exit (Sources of Monopoly Power). When the copyright on a work expires, the work is transferred to the public domain, enabling others to repurpose and build on the work. The government creates legal barriers through patents, copyrights, and granting exclusive rights to companies. (Figure) presents a long-run average cost curve for the airplane manufacturing industry. The total cost of the natural monopoly is lower than the sum of the total costs of two firms producing the same quantity. Hence, the number of firms in such industries decreases … Moreover, the costs of transporting cement over land are high, and so a cement plant in an area without access to water transportation may be a natural monopoly. In both types of government-initiated monopoly competition is kept out of the market through laws, regulations, and other mechanisms of government enforcement. Barriers to entry. A copyright gives the creator of an original creative work exclusive rights to it for a limited time. Intellectual property rights, such as patents and copyright, give the rights holder exclusive control over the production and sale of certain goods. Although in recent years they have experienced growing competition, their impact on the rough diamond market is still considerable. Consider a large airline that provides most of the flights between two particular cities. In contrast, a natural monopoly will have a marginal cost that is constant or declining, and an average total cost that drops as the quantity of output increases. In a government-granted monopoly, the government gives a private individual or a firm the right to be a sole provider of a good or service. Principles of Economics 2e by Rice University is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted. Monopolies exhibit decreasing costs as output increases. In this world of near ubiquitous information, other companies could take the formula, produce the drug, and because they did not incur the costs of research and development (R&D), undercut the price of the company that discovered the drug. In the United States, exclusive patent rights last for 20 years. Vist this website for examples of some pretty bizarre patents. In other instances, the government may be an invested partner in a monopoly rather than a sole owner. Other firms are discouraged from entering the market because of the high initial costs and the difficulty of obtaining a large enough market share to achieve the same low costs as the monopolist. Entry and Exit Decisions in the Long Run; Efficiency in Perfectly Competitive Markets; Chapter 25. Government-granted monopolies and government monopolies differ in the decision-making structure of the monopolist. Ownership of key resources or raw material: Having control over scarce resources, which other firms could have used, creates a very strong barrier to entry. It was granted exclusive trading privileges with colonial possessions under mercantilist economic policy. When barriers to entry exist, perfect competition is no longer a reasonable description of how an industry works. Tuteja (Lecture Notes, IIFT) Business Economics MBA IB (2020-22) Introduction What are Barriers to Entry and Exit? In instances when producers refused to join, De Beers flooded the market with diamonds similar to the ones they were producing. Another example is that the Digital Millenium Copyright Act the proprietary Macrovision copy prevention technology is required for analog video recorders. One is natural monopoly, where the barriers to entry are something other than legal prohibition. Trademarks are enforced by government, and therefore are a barrier to entry. Examples of natural monopolies are water and electricity services. This makes competing goods or services with lower levels of adoption unattractive to new customers. There are ongoing negotiations, both through the World Intellectual Property Organization (WIPO) and through international treaties, to bring greater harmony to the intellectual property laws of different countries to determine the extent to which those in other countries will respect patents and copyrights of those in other countries. Natural monopolies tend to form in industries where there are high fixed costs. As another example, the majority of global diamond production is controlled by DeBeers, a multi-national company that has mining and production operations in South Africa, Botswana, Namibia, and Canada. Give some examples. Network externalities (also called network effects) occur when the value of a good or service increases as a result of many people using it. There are several different types of barriers to entry. Demonstrate an understanding of how a natural monopoly is created. This is a market that has very low barriers to entry and exit and the cost to new firms is the same as incumbent firms. Natural monopolies have overwhelming cost advantages over potential competitors. Monopoly. Unfair taxes (high taxes or tax-breaks for others) also frequently constitute barriers to competition. If there were no (or only low) barriers, other firms would enter such markets to participate in the monopoly profits. Why are generic pharmaceuticals significantly cheaper than name brand ones? This is because when a person uses software that is used by so many others, he or she is less likely to run into compatibility problems in the course of work or other activities. By the end of this section, you will be able to: Because of the lack of competition, monopolies tend to earn significant economic profits. As it gains market share and increases its output, the fixed cost is divided among a larger number of customers. Explain the relationship between resource control and monopolies. In the monopoly market, if need to entry a new firms that will get a strict barriers to entry. One famous trade secret is the formula for Coca-Cola, which is not protected under copyright or patent law, but is simply kept secret by the company. Quite simply, if you are struggling to get the funds together to start the business, then this is a 'barrier' to you entering the market. (adsbygoogle = window.adsbygoogle || []).push({}); Control over a natural resource that is critical to the production of a final good is one source of monopoly power. Barriers to entry are natural or legal restrictions that restrict the entry of new firms into the business world. These 'unrecoverable' costs are often referred to as sunk costs. 4. Moreover, Stigler (1968) rejected the basic notion that scale economies can create an entry barrier. This is a government-enforced barrier to entry. These industries offer an example where, because of economies of scale, one producer can serve the entire market more efficiently than a number of smaller producers that would need to make duplicate physical capital investments. A natural monopoly ‘s cost structure is very different from that of most industries. For example, most people use Microsoft word processing software. The United States Postal Service is another example of a government monopoly. When barriers to entry are high enough, monopoly can result. Examples include steel production, pharmaceuticals, and space transport. Even if a company does not have a patent on an invention, competing firms are not allowed to steal their secrets. In some cases, the government will grant a person or firm exclusive rights to produce a good or service, enabling them to monopolize the market for this good or service. For example, once a water company lays the main water pipes through a neighborhood, the marginal cost of providing water service to another home is fairly low. What is a barrier to entry? Entry barriers (or barriers to entry) are obstacles that stop or prevent the entrance of a firm in a specific market. Markets with a low exit barrier are stable and self-regulated, so the profit margins do not fluctuate much over time. This allows the company to recoup the cost of developing this particular drug. One example is Microsoft spreadsheet and word processing software, which is still used widely. A new, small start-up airline decides to offer service between these two cities. Least cost firm as a price leader ... Losses are acceptable only in the short run, and lead to exit in the long run. to Promote the Progress of Science and Useful Arts, by securing for limited Times to Authors and Inventors the Exclusive Right to their Writings and Discoveries.” Congress used this power to create the U.S. Patent and Trademark Office, as well as the U.S. This makes it difficult for new companies to enter the market and to gain market share. Estimate what would happen to the market price as a result of the supply of both the incumbent firm and the new entrant. The reverse is also true. Barriers to entry seek to protect the power of existing firms and maintain supernormal profits and increase producer surplus. There are two types of monopoly, based on the kinds of barriers to entry they exploit. Barriers may block entry even if the firm or firms currently in the market are earning profits. It convinced independent producers to join its single channel monopoly. For example, imagine there are two firms in a natural monopoly’s market and each of them produces half of the quantity that the monopoly produces. In other industries, the marginal cost initially decreases due to economies of scale, then increases as the company experiences growing pains (as employees become overworked, the firm’s bureaucracy expands, etc.). Some of the common barriers to entry and exit are listed below. Economies are large, usually with multiple people owning resources. Scale of Production Barrier - the monopoly would be producing on a large scale and newer industries wouldn't be able to compete It was created through laws that ban potential competitors from offering certain types of services, such as first-class and standard mail delivery. Natural monopolies arise as a result of economies of scale. Monopolies derive their market power from barriers to entry: circumstances that prevent or greatly impede a potential competitor’s ability to compete in the market. A network effect is the effect that multiple users have on the value of a good or service to other users. How is intellectual property different from other property? Thus, in markets with significant barriers to entry, it is not necessarily true that abnormally high profits will attract new firms, and that this entry of new firms will eventually cause the price to decline so that surviving firms earn only a normal level of profit in the long run. For some products, the government erects barriers to entry by prohibiting or limiting competition. Patents, … Once the electric company installs lines in a new subdivision, the marginal cost of providing additional electrical service to one more home is minimal. Economies of scale are also gained through bulk-buying of materials with long-term contracts, the increased specialization of managers, ability to obtain lower interest rates when borrowing from banks, access to a greater range of financial instruments, and spreading the cost of marketing over a greater range of output. Listed below are some of the common barriers to entry and exit. A natural monopoly arises as a result of economies of scale. This is a barrier to entry, but it is not government-enforced. De Beers Consolidated Mines were founded in 1888 in South Africa as an amalgamation of a number of individual diamond mining operations. Intellectual property rights, including copyright and patents, are an important example of legal barriers that give rise to monopolies. The supply of natural resources such as precious metals or oil deposits is limited, giving their owners monopoly powers. In a government-granted monopoly, business decisions are made by a private firm. In a government-granted monopoly, the government gives a private individual or a firm the right to be a sole provider of a good or service. Copyright Office, “is a form of protection provided by the laws of the United States for ‘original works of authorship’ including literary, dramatic, musical, architectural, cartographic, choreographic, pantomimic, pictorial, graphic, sculptural, and audiovisual creations.” No one can reproduce, display, or perform a copyrighted work without the author’s permission. Predatory pricing, as well as an acquisition: A firm may deliberately lower prices to force rivals out of the market. Being the first mover in the industry. Strategy for Information Markets/Monopoly. Legal rights can provide an opportunity to monopolize a market for a good. Control Over Natural Resources De Beers had a monopoly over the production of diamonds for most of the 20th century, and it used its dominant position to manipulate the international diamond market. Small firm cannot enter the industry as small scale producer cannot achieve the lowest average total cost and resultantly cannot get profit necessary for s… Under U.S. law, no organization but the U.S. Capital intensive - A large capital investment per unit of output in facilities tends to limit industry entry. Most legal monopolies are utilities—products necessary for everyday life—that are socially beneficial. Economies of scale are cost advantages that large firms obtain due to their size.They occur because the cost per unit of output decreases with increasing scale, as fixed costs are spread over more units of output. At that case the economies of scale act as barrier to enter industry. A city passes a law on how many licenses it will issue for taxicabs, A city passes a law that all taxicab drivers must pass a driving safety test and have insurance, Owning a spring that offers very pure water, An industry where economies of scale are very large compared to the size of demand in the market. Barriers to entry are the legal, technological, or market forces that discourage or prevent potential competitors from entering a market. However, in certain areas, like the invention of new software, it has been unclear whether patent or copyright protection should apply. In some cases, large advertising budgets can also act as a way of discouraging the competition. In other words, resource control allows the controller to charge economic rent. These profits should attract vigorous competition as we described in Perfect Competition, and yet, because of one particular characteristic of monopoly, they do not. It is also possible that there is a monopoly because the government has granted a single company exclusive or special rights. What legal mechanisms protect intellectual property? This is an example of a government law, but perhaps it is not much of a barrier to entry if most people can pass the safety test and get insurance. For example, when a pharmaceutical company first markets a drug, it is usually under a patent, and only the pharmaceutical company can sell it until the patent expires. Shorter patent protection would make innovation less lucrative, so the amount of research and development would likely decline. How do you suppose their barriers to entry were weakened? There are instances in which the government initiates monopolies, creating a government-granted monopoly or a government monopoly. There are cases in which a government agency is the sole provider of a particular good or service and competition is prohibited by law. 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