Question

Barriers to entry are crucial in determining the market structure. Discuss, with appropriate examples, government created barriers to entry that businesses are likely to encounter in the UAE market

3(b). One simple measure of a firm’s market power is the Lerner index. Suppose a firm faces a demand curve defined as P=40, and MR=40. Its marginal cost is given by MC=5+5Q. Compute its Lerner index and explain the market structure it is operating in [3 marks].

Answer 1

The structure of a market depicts the existence of firms in a particular market and to what extent the firms constituting a specified market are functionally interrelated to each other. The term ‘market structure’ refers to the degree of competition prevailing in that particular market. The power of an individual firm to control the market price by changing its own output determines the degree of competition and this power varies inversely with the degree of competition. The higher the degree of competition, the less market power the firm has and vice-versa. Market power is generally thought to be the ability of the firm to influence price.

Barriers to entry act as a deterrent against new competitors. They serve as a defensive mechanism that imposes a cost element to new entrants, which incumbents do not have to bear. Entry barriers can be both exogeneously and endogenously determined. Firms in the industry donot have control over exogenous barriers.

Exogenous determinants of entry barriers might derive from basic demand and cost conditions, because demand conditions are determined by consumers and cost conditions are technologically determined. They can also include government regulations that legally restrict entry. Examples include a patent or a government franchise that limits the number of competitors, such as your local cable television company. Barriers that are caused by basic economic conditions are called natural barriers to entry. Those that are caused by government restrictions are called legal barriers to entry.

Barriers that are endogenous are sometimes called strategic barriers to entry because they are under the control of firms in the industry and are specifically designed to deter entry. These include a variety of predatory activities that are profitable only because they drive existing competitors out of business or deter potential competitors from entering the market. Examples include predatory pricing, where price is cut below unit cost, and actions that raise rival costs.

Economies of scope arise when cost of producing two or more goods together is less costly than producing the two goods separately. The process goes on and becomes cost effective as more goods are produced. This acts as entry deterrent for new firms. New Product Development: Producing substitutes for its own product in the market can discourage the entry for the new firms.

demand curve is perfectly elastic that means price elasticity of demand is negative infinifty

if elasticity of demand is large, the firm has less market power, and a small markup

firm is operating in perfect competition