Barriers to Entry and monopolies

Yesterday, starting with a nice parable produced by Frederick Bastiat, I talked a bit about capital and interest and why those who own capital–the means of production (not money; money is just something that can be traded for capital).–are entirely deserving of being compensated for making that capital available to others to use and that the compensation is based on what capital is made available not how much a particular person has.  A particular amount of capital rates so much compensation, whether that capital is owned by one person or split up between two, ten, or ten thousand.  You can’t charge too much for the use of that capital (Whether it’s a plane, or a rolling mill, or a semiconductor fabrication facility) or people will produce their own rather than use yours and pay the compensation you demand.

Or that will be the case if there aren’t barriers to entry.

Let’s go back to James and his plane.  James wants to charge more for his plane but he finds when he does so his customers, instead of paying his higher charges, say “no” and take the time to make their own planes.  The revenue they lose for taking the time to make their own plane is less than James is charging.  James either has to lower his prices or watch his customers go away.

Enter government to provide a third option.

James goes to the local Baron shows him his plane, explains how using that plane folk can make fine, splinter-free thrones for the Baron to sit upon and fine tables for his feast halls.  But other people are making planes too.  And, well, who knows what quality they are.  Really, they should not be able to do that.  And if those inferior planes were prohibited and only James were allowed to make planes, why James would be able to contributed, say 10% of the charge from renting out planes to the Baron’s feast fund.

The Baron’s stricture that only James shall be allowed to make and provide planes in the Barony is what we call a Barrier to Entry.

Barriers to Entry are anything that gets in the way of competition.

And you don’t need a complete ban to have a barrier to entry.  If, for instance, James simply suggested that anyone making planes should complete a year long “plane building course” then anyone coming in would have to charge for their planes based on the cost to them of that year spent just completing the course.  And James, already comfortably in the field, can charge that higher price confident that no one is going to undersell him.

Some barriers to entry are natural.  If a particular field requires unusual skill or talent few people will be successful in it.  The ability to hit a major league fastball is a pretty strong barrier to entry to playing major league baseball (and/or throw or field that major league fastball).  This means players can charge pretty high salaries without fear of thousands of others who can do the same thing for less money.

Same principle if something requires a rare or difficult to access resource.  Lack of that resource, or lack of access to it, is a barrier to entry.

This is how monopolies happen.  There are only two ways you can have a monopoly.  The first is that someone is so good at providing a good or service that they give better value than any potential competitors.   The second is where barriers to entry are imposed artificially.  And this second category is almost entirely the result of government regulation.  It takes force to impose such a barrier.  And the only organization that can lawfully (pretty much by definition) use force is government.

Government regulation serves as a barrier to entry and always either increases the cost of goods and services or creates a shortage.

Now let’s look at that first category of monopoly–where someone is so good that they can undersell all competitors and so the competitors go out of business.  When that happens, people wring their hands and worry that once the competition is gone, the monopoly can then raise its prices without limit.  However, in the absence of barriers to entry the moment they do that competitors can once again arise.  They cannot raise their prices higher than that required to make competitors profitable.

So the question should not be “is there a monopoly” but rather “is the monopoly caused by artificially imposed barriers to entry.

From a strictly economic point of view, you want the fewest barriers to entry as possible.  Ideally only natural ones and even those we would do well to mitigate.

Now, there are situations where its advisable, for reasons other than economic to distort things from the ideal “minimum barriers to entry–let everything sink or swim on its own” approach.  But that’s a topic for another day.

 

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1 thought on “Barriers to Entry and monopolies”

  1. If James owned a trucking company, instead of manufacturing planes, then you would have, pretty accurately, captured a big part of the problem in MY industry.

    I have never had much problem with monopolies, at least not monopolies that pop up due to lack of government interference. The monopoly won’t last forever. Someone will find that they are dissatisfied with the product or service offered by the monopoly, ask a few questions, discover that others are also unhappy, and create a competition.

    I note that, in my small town, where a Walmart came in, all the little storefronts seem to be occupied by local businesses that offer SOMETHING that is not available at Walmart. In some cases, it’s simply a more personal level of service. In others, it’s a particular product (as well as a more personal level of service).

    Monopolies, no matter the product or service offered, will inevitably provide mediocrity. And, there will always be folks who will find that to be unexceptable.

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