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Monopoly
Barriers to Entry: Reasons for Monopolies to Exist
Economics Textbooks Boundless Economics Monopoly Barriers to Entry: Reasons for Monopolies to Exist
Economics Textbooks Boundless Economics Monopoly
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Concept Version 6
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Other Barriers to Entry

Firms gain monopolistic power as a result of markets' barriers to entry, which discourage potential competitors.

Learning Objective

  • Identify the common conditions that lead to monopolistic power


Key Points

    • There are several different types of barriers to entry, including a firm's control over scarce natural resources, high capital requirements for an industry, economies of scale, network effects, legal barriers, and government backing.
    • Some industries require large investments in capital or research and development, making it difficult for new firms to enter.
    • Monopolies benefit from economies of scale, which give them a cost advantage over their competitors.
    • The legal system can grant firms monopoly rights over a resource or production of a good.

Terms

  • Barriers to entry

    Circumstances that prevent or greatly impede a potential competitor's ability to compete in the market.

  • Network effects

    When the value of a product or service is dependent on the number of people using it.


Full Text

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. There are several different types of barriers to entry.

Control Over Natural Resources

The supply of natural resources such as precious metals or oil deposits is limited, giving their owners monopoly powers. For example, De Beers controls the vast majority of the world's diamond reserves, allowing only a certain number of diamonds to be mined each year and keeping the price of diamonds high .

Diamond

De Beers controls the majority of the world's diamond reserves, preventing other players from entering the industry and setting a high price for diamonds.

High Capital Requirements

Some production processes require large investments in capital or large research and development costs that make it difficult for new companies to enter an industry. Examples include steel production, pharmaceuticals, and space transport.

Economies of Scale

Monopolies exhibit decreasing costs as output increases. Decreasing costs coupled with large initial costs give monopolies a cost advantage in production over would-be competitors. Market entrants have not yet achieved economies of scale, so their output simply costs so much more than the incumbent firms that market entry is difficult.

Network Effects

The use of a product by other people can increase its value to a person . One example is Microsoft spreadsheet and word processing software, which is still used widely. 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. This tendency to use what everyone else is using makes it difficult for new companies to develop and sell competing software.

Facebook

Network effects are one reason why it's so difficult for new companies to compete against Facebook: they simply will have difficulty establishing a network of users to compete.

Legal Barriers

Legal rights can provide an opportunity to monopolize a market for a good. Intellectual property rights, such as patents and copyright, give the rights holder exclusive control over the production and sale of certain goods. Property rights may give a company exclusive control of the materials necessary to produce a good. The granting of permits or professional licenses can also favor certain firms, while setting standards that are difficult for new firms to meet.

Government Backing

There are cases in which a government agency is the sole provider of a particular good or service and competition is prohibited by law. For example, in many countries, the postal system is run by the government with competition forbidden by law in some or all services. Government monopolies in public utilities, telecommunications systems, and railroads have also historically been common. In other instances, the government may be an invested partner in a monopoly rather than a sole owner. This will still make it difficult for competitors to operate on equal footing.

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