[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

government gave the East India Company a monopoly on trade with India. More
recently, governments have often granted monopolies to providers of such services
as electricity, telephones, and cable television. Today, however, the most important
monopolies granted by governments are patents. A patent gives inventors the exclusive
right to produce or license others to produce their discoveries for a limited
period of time (generally twenty years). The argument for patents is that without
property rights in their discoveries, inventors would have no economic incentive
to innovate. The framers of the U.S. Constitution thought promoting “the Progress
of Science and useful Arts” to be so important that they included the granting of
patents among the powers of the newly created Congress.
Single Ownership of an Essential Input Another barrier to entry is a
firm’s exclusive ownership of some raw material. For example, an aluminum company
might attempt to become a monopolist by buying all the sources of bauxite,
the main ore of aluminum. A single South African company, De Beers, has come
close to monopolizing the world’s supply of diamonds.
Information as a Barrier to Entry Information can act as a barrier to entry
when consumers do not know and cannot easily assess the quality of a new product.
In the computer printer market, for example, firms such as HP, Epson, and Canon dominate;
because these firms have already established reputations for producing highquality
printers, a new entrant unknown to consumers would need to sell at a price
significantly below those of the other firms. Imperfect information about the production
costs and responses of incumbent firms too can act as a barrier to entry. Potential
entrants may know that they can undercut the incumbent firm’s current price, but they
do not know how much the incumbent will (or can afford to) lower its prices.
Market Strategies for Entry Deterrence Established firms often pursue
strategies to convince potential entrants that even though they are currently making
high levels of profits, these profits will disappear if the new firm enters the market.
Two major forms of such entry-deterring practices are predatory pricing and
excess capacity.
In predatory pricing, an incumbent firm deliberately lowers its price below the
new entrant’s cost of production in order to drive the new arrival out and discourage
future entry. The incumbent may lose money in the process, but it hopes to
recoup its losses when the entrant leaves and it is free to raise prices back to the
monopoly level. Predatory pricing is an illegal trade practice, but changing technologies
and shifting demand often make it difficult to ascertain whether a firm has
actually engaged in predatory pricing or has simply lowered its price to meet the
competition (see the following Thinking Like an Economist box).
Firms can also build more production facilities than are currently needed. By
readying extra plants and equipment—excess capacity—even if they are rarely
used, the incumbent sends a signal to potential entrants that it is willing and able
to engage in fierce price competition.
These strategies are most likely to be effective if there are some sunk costs.
Assume the incumbent firm has constant marginal costs and can respond to the
entry of another firm by lowering its unit price to marginal cost. A potential entrant,
282 ∂ CHAPTER 12 MONOPOLY, MONOPOLISTIC COMPETITION, AND OLIGOPOLY