Normal profit is AC=AR
MC=MR
Profit max - MC=MR

Short run to long run:-

Abnormal profits act as a signal
New firms enter the industry and increase supply
Price falls and abnormal profits are "competed away"

BARRIERS TO ENTRY

BARRIERS TO ENTRY anything that stops new firms entering a particular market; they tend to be more prevalent as the degree of competition in the market decreases

The main barriers to entry include:-

HIGH SUNK COSTS costs that a firm cant recover when leaving a market eg advertising, licencing fee
HIGH INITIAL COSTS includes capital investment eg equipment, buildings
CONTROL OF RETAIL OUTLETS eg Tesco buying plots of land and old premises
CONTROL OF THE SUPPLY OF RAW MATERIALS eg Tesco buying farms to produce raw materials
ECONOMIES OF SCALE incumbent firms (already in the market) may have grown and experienced decreases in LRAC (meaning they charge lower prices and can protect their profit margins)
EXISTENCE OF BRAND LOYALTY incumbents reputation may mean new entrants face higher costs of persuasive advertising

Where barriers to entry are low the market is sometimes described as being contestable. In this situation there are potential competitors even if few actually appear

CONTESTABILITY AND BARRIERS TO ENTRY AND EXIT

CONTESTABILITY the extent to which barriers to entry and exit in a market are free and costless

INCUMBENT FIRM a firm that is already operating in a market

Most argue its the degree of contestability that determines the level of competition rather than the number of firms
A contestable market occurd when the behaviour of incumbent firms is influenced by both existing and potential competitors , who can enter the industry at:-

Relatively low cost
Take advantage of abnormal profit while available
Leave the industry at low cost (hit and run)

The existence of barriers to entry and/or exit therefore influences the level of contestability within an industry
A perfectly contestable market exists where:-

All firms are subject to the same regulations and the same state of technology
Mechanisms are in place which prevent entry, limit pricing by incumbent firms
Incumbent firms are vulnerable to "hit and run" competition

Contestability is more likely to be found in a perfectly competitive market than any other
Incumbent firms in a perfectly contestable market may moderate their behaviour in an attempt to discourage potential entrants eg just making normal profit even if abnormal profit is obtainable
Incumbent firms may also seek to erect artificial barriers to entry such as increasing levels of consumer loyalty which deter potential entrants when incumbent firms change their strategy and seek to maximise profits in the short run

THE OBJECTIVES OF FIRMS: PROFIT MAXIMISATION

The break even point is usually whether a profit or loss is made
Abnormal profit is the reward for risk taking and managing resources

	Created by samyajahangir about 9 years ago

A Level A2 Economics Note on Market Structures - Perfect Competition and Monopoly, created by samyajahangir on 30/03/2015.