1.2.4 - Monopoly and barriers to entry

Monopoly and price making

A monopoly has much greater control over its market than a firm facing many close rivals.

The relevant market must be clear. A firm's national market share may be small while it is the only accessible supplier in an isolated town. A monopoly's product is unique in the sense that there is no close substitute within the relevant market. This does not mean consumers have no other way to spend their money. An only ferry operator may still lose some travellers to a much longer road journey.

A monopoly is a price-maker: it can influence price by its supply and pricing decisions because customers have few close alternatives. It cannot charge any price and sell any quantity it wishes. A higher price can discourage purchases, and affordability or possible substitute products limit its power. One dominant supplier and weak competitive pressure make price making possible; barriers to entry help that position last.

Legal barriers and patents

A barrier to entry makes it difficult for a potential competitor to start supplying the market.

Legal barriers arise from rules or rights that restrict entry. If a licence gives one business the exclusive right to operate a local service, a rival cannot simply open next door. Licensing can protect safety or coordinate a network, but an exclusive licence also restricts competitive pressure. Having to satisfy a reasonable safety rule is different from being legally forbidden to compete.

A patent gives its owner temporary legal protection over an invention, preventing others from using the protected invention without permission. It can encourage innovation: an inventor is more willing to fund research if competitors cannot immediately copy the successful design. During protection, however, customers may face fewer suppliers and higher prices. A patent does not protect every product forever; its effect depends on the protected technology and the availability of other solutions.

For an illustrative inventor developing a new water-filter mechanism, a patent may make expected future earnings large enough to justify research costs. A rival must obtain permission or develop a different design. The same protection that rewards invention creates an entry obstacle.

Commercial barriers to entry

Entry can be difficult even when the law permits a new firm to compete.

A dominant firm's large marketing budget can create brand recognition and loyalty. A new supplier may have to spend heavily before buyers trust it. Advertising does not legally prevent entry, but the expenditure needed to win customers can make entry unattractive.

Advanced technology can be a barrier when a rival lacks the expertise, specialist equipment or access to an effective production system. The incumbent may produce at a cost a new entrant cannot initially match. Technology is distinct from a patent: a technique can be hard to reproduce even without legal protection.

High start-up costs mean substantial spending is necessary before any sales occur. Building a railway network or a large processing plant requires more capital than opening a small market stall. If the established supplier already serves most buyers, a new entrant may fear that its expensive capacity will be underused. Economies of scale can reinforce this barrier because a small entrant begins with higher average costs than the established large producer.