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In most cases, monopoly and oligopoly exist when barriers to entry are extremely high. It happens due to patents, technology, concentrated industry, distribution overheads, or government regulation (Miller, Osborne, & Sheu, 2017).
There are two main types of entry barriers, namely, structural (natural), and strategic (artificial). The structural entry barriers are:
- Network effects. A positive network effect for new entrants may be limited by the already existing network of people who use specific goods or services.
- Scarce resources. When a company owns scarce resources, for example, the airline controlling access at an airport, they create a barrier to entry for other companies.
- High set-up costs. When a company leaves a market, these costs include advertising, marketing, and other costs, and they cannot be recovered.
- High R&D costs. New entrants cannot match the existing companies’ level of spending money on research and development (Stringham, Miller, & Clark, 2015).
The strategic entry barriers are:
- Predatory pricing. A company deliberately lowers prices in order to exclude rivals from the market.
- Limit pricing. A company may set a low price and a high output thereby making it impossible for new entrants to make a profit.
- Predatory acquisition. A company may purchase a significant share to gain control over a new entrant, or completely buy it.
- A strong brand. Customers become loyal to the already existing brand thereby deterring new entrants (Stringham et al., 2015).
In order to get a perfect and fair competition in favor of consumers, the U.S. government introduced antitrust laws beginning with the Sherman Act in 1890. Then, in 1890, two other laws were introduced, namely, the Clayton Act, and the Federal Trade Commission Act. These laws are now still in effect but with some amendments (Miller et al., 2017).
It is argued by Adam Smith and some other economists that these laws are aimed at providing benefits solely to consumers and overall efficiency thereby interrupting the concept of the free market. Additionally, to certain categories of business such as Banks, Insurance, Media, Healthcare, and so on, the antitrust laws do not apply (Miller et al., 2017).
Due to the absence of government regulation in concentrated industries, companies usually abuse their power causing productive and allocative inefficiency. However, in some industries, the most efficient number of companies is very low due to the economies of scale, such as the airline industry or pharmaceuticals; therefore, in these industries, a higher concentration ratio would be beneficial (Miller et al., 2017).
Miller, N. H., Osborne, M., & Sheu, G. (2017). Pass‐through in a concentrated industry: Empirical evidence and regulatory implications. The RAND Journal of Economics, 48(1), 69-93.
Stringham, E. P., Miller, J. K., & Clark, J. R. (2015). Overcoming barriers to entry in an established industry. California Management Review, 57(4), 85-103.