This
paper explains how the degree of market dominance, which results from the level
of barriers to entry in an industry, will affect the amount of profits earned
by a firm, which is assumed to be a profit-maximising entity.
First,
it has to be observed that a firm with market dominance will have a downward
sloping demand curve. The higher the market dominance a firm has, the higher
its price setting ability, and this results in a more price inelastic demand
curve. The higher the ability of the firm to increase total revenue (TR, which is equal to P x Q), since
an increase in price would lead to a less than proportionate fall in its
quantity demanded, the more likely this would in turn indicate more profits for
the firm, assuming no change in the total cost (TC). Market dominance and price
setting ability arise because of the presence of barriers to entry.
What
are barriers to entry? Barriers to entry refer to any man-made or natural barriers which
are strong enough to prevent new rival firms from competing on an equal basis
with the existing firms. A perfectly competitive and monopolistically
competitive market structure both have no and low barriers to entry and exit
respectively. Thus, a perfectly competitive firm possesses no market dominance
and a monopolistically competitive firm possesses low market dominance. There
are substantial barriers to entry and exit in an oligopolistic market and for a
monopoly it has the highest level of barriers to entry and exit. Thus, an
oligopoly and monopoly possess a high degree of market dominance. Due to the
varying degrees of barriers to entry, the different market structures will see
a different impact on the amount of profits earned in the long run. The amount
of profits can take the form of supernormal profits (TR>TC), normal profits
(TR=TC) or subnormal profits (TR<TC). In a perfectly competitive market,
there are no barriers to entry. This implies that firms are free to enter and
exit the market.
Explain
using diagrams, how the PC firm eventually makes normal profits
In
contrast, should a perfectly competitive firm be earning subnormal profits
initially, this will cause some firms to leave the industry and decrease the
market supply. This will in turn increase the market price and diminish the
magnitude of subnormal profits. Firms will continue to leave the industry until
the remaining firms earn normal profits in the long run.
Similarly,
in a monopolistically competitive market, there are low barriers to entry in
reality.
Explain
using diagrams, how the MC firm eventually makes normal profits
In
contrast, a monopoly faces high barriers to entry. If the monopolist is making
supernormal profit initially, new firms cannot easily enter the market even
when there are supernormal profits to be made. There will be no change to the
firm’s demand and it can continue to retain its supernormal profits. Likewise
for a firm in an oligopolistic market, it also faces considerable barriers to
entry. As it is difficult for firms to enter or exit easily, an oligopolistic
firm’s supernormal profits will not be whittled away and can continue to retain
its supernormal profits in the long run.
In
conclusion, the higher the degree of market dominance as a result of higher
barriers to entry, the higher the degree of profits earned by the firm in
question, which usually means ultimately that oligopolies and monopolies earn
supernormal profits while perfectly competitive and monopolistic firms earn
normal profits.
JC Economics Essays - This economics essay was contributed by a student from a certain Junior College in Singapore. It was not written under timed examination conditions, but is supposed to reflect the best possible answer given by a candidate to the economics question about the degree of market dominance and how it affects a firm's profitability. Special thanks to S for his contribution to this economics blog.
What comments would an economics tutor make about this essay response? First, take note that this is a purely theoretical question. Many times, candidates have to determine if the question is asking a purely theoretical question (usually the small part questions of CSQ or the 10 mark questions are about theory), or if the real world context is required. Often, the larger essay questions require application of economics to the context, or real world examples. In this case, this economics question seems to be a pure theory question testing if students understand the concepts of market structure, market dominance, barriers to entry, and the type of profits. While this essay is excellently crafted, perhaps there could be a more efficient way of writing it? While the material is sound and accessible to A level students, could there be a more parsimonious way of writing this paper, given that it is only 10 marks? Are there alternative approaches to answering this economics question? On the other hand, the level of detail is excellent and this paper deserves a very high grade for its targeted yet detailed response. Think about how you would approach this essay. Thanks for reading and cheers!
