Entry/Exit .1, .2

Question 1

What is an entry barrier?

Answer 1

An obstacle/ restriction making it difficult for firms to enter a market

• EoS
• Capital Requirements

Question 2

What is a sunk cost and what does it depend on?

Answer 2

A sunk cost is a cost that produces some benefits in the long run but is unrecoverable

A sunk cost is dependent on the time frame in question (eg. Fixed costs are sunk in the S-R)

Question 3

Why are sunk costs a barrier to entry? (What assumptions)

Answer 3

[Assume homogenous products, Bertrand competition]

With sunk cost -> entry will result in Bertrand competition where p=MC (no profit)… with sunk entry cost Entry = unprofitable :. No entry

With partial recovery for sunk cost -> (same situation but) entry incentivises Incumbent to leave -> one monopoly replaces other

Question 4

When is free entry socially efficient? What are the assumptions for (…)

Answer 4

During Perfect competition

[Perf Comp assumes]:
- Homogenous Products
- Firms = price takers
- Homogenous costs
- (No entry barriers)

Question 5

When does free entry result in excessive entry? Why?

Answer 5

When price competition is weak/ product differentiation unimportant.

(Comp weak->) firms are price makers… entry will result in ‘business stealing effect’… the gain in total welfare < entrant firm profits (potential cost to enter market)

[reality of differing costs -> dynamic entry and exit as less efficient firms replaced by more efficient firms]

Question 6

When does free entry result in insufficient entry? Why?

Answer 6

When price competition is strong/ product differentiation is important.

Entry + positive externality gained from more variety. Entrants are not able to capture the full consumers’ WTP