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Oligopoly
Prerequisites of Oligopoly
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Concept Version 6
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Entry Barriers

One important source of oligopoly power are barriers to entry: obstacles that make it difficult to enter a given market.

Learning Objective

  • Explain the necessity of entry barriers for the existence of an oligopoly


Key Points

    • Because barriers to entry protect incumbent firms and restrict competition in a market, they can contribute to distortionary prices.
    • The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy new entrants.
    • In industrialized economies, barriers to entry have resulted in oligopolies forming in many sectors, with unprecedented levels of competition fueled by increasing globalization.

Terms

  • incumbent

    A firm that is an established player in the market.

  • research and development

    The process of discovering and creating new knowledge about scientific and technological topics in order to develop new products

  • patent

    A declaration issued by a government agency declaring someone the inventor of a new invention and having the privilege of stopping others from making, using, or selling the claimed invention.


Full Text

One important source of oligopoly power is barriers to entry. Barriers to entry are obstacles that make it difficult to enter a given market. The term can refer to hindrances a firm faces in trying to enter a market or industry—such as government regulation and patents, or a large, established firm taking advantage of economies of scale—or those an individual faces in trying to gain entrance to a profession—such as education or licensing requirements. Because barriers to entry protect incumbent firms and restrict competition in a market, they can contribute to distortionary prices.

The most important barriers are economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy new entrants. For example, microprocessing companies face high research and development costs before possibly making a profit. This means that new firms cannot enter the market whenever existing firms are making a positive economic profit, as is the case in perfect competition. Pharmaceutical manufacturers are one type of company that generally rely on patents, which makes competition irrelevant for a period of time after development: competitors can't legally begin manufacturing the product until the patent expires.

Additional sources of barriers to entry often result from government regulation favoring existing firms. For example, requirements for licenses and permits may raise the investment needed to enter a market, creating an effective barrier to entry.

In industrialized economies, barriers to entry have resulted in oligopolies forming in many sectors, with unprecedented levels of competition fueled by increasing globalization. For example, there are now only a small number of manufacturers of civil passenger aircraft. Oligopolies have also formed in heavily-regulated markets such as wireless communications: in some areas only two or three providers are licensed to operate .

Oligopoly in Aircraft Manufacturing

Manufacturing commercial airplanes takes a very large initial investment in technology, equipment, and licensing. Consequently, the industry is dominated by two firms.

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