Firms pricing and output decisions depend on

barriers to entry and the behaviour of

competitors. Discuss. [25]
Barriers to entry are the obstacles a firm will face when trying to enter a new market,
and may be either artificial or natural. Artificial barriers to entry include brand loyalty
of consumers to incumbent firms or rules and regulations that make it harder to enter
the market. Natural barriers to entry include significant internal economies of scale
and large startup costs.
Barriers to entry directly affect the number of firms in a market. The larger the
barriers to entry, the smaller the number of firms in the market, as it is harder for
firms to enter the market. This will thus impact the ability of the firms to set their own
prices, in addition to how responsive firms are to the actions of their competitors.
All firms aiming to maximise profits will produce at the profit maximising output where
MC=MR, and will charge the maximum price for which consumers are willing and
able to pay for that amount of good. For a firm with little or no barriers to entry, this
must be where Price= LRAC= AR in the long run, and for a firm with high barriers to
entry, this may not be the case. Additionally, firms in the latter group may choose to
pursue other objectives, without worrying about their survival. A firm with no barriers
to entry will also need to sell the good where P=MC.
In perfect competition, there are no barriers to entry, as such, there are many many
firms in the market, all of which do not have a say over how to price their good.
Instead, prices are wholly determined by market forces of demand and supply. These
firms are termed as price takers. As such, their average revenue and marginal
revenue are perfectly elastic and equal.

From the above figure, it is evident that the initial price of the good, P1, is dependent
on the demand and supply force of the good, Dd and Ss. Initially, the perfectly
competitive firm was enjoying supernormal profits of P1ABP2. These supernormal
profits will then draw more firms into the market, increasing the supply of the good
from SS to SS2. This will cause a drop in the price from P1 to P2, and an erosion of
the supernormal profits initially enjoyed by the firm, until the price is equal to the
lowest point on the LRAC, and no more supernormal profit is earned.
Therefore while the price of the good is independent of the actions of competitors
when the market is in equilibrium in the long run, the price of the good and the output
quantity decided by the firm in the short run is heavily dependent on the actions of
their competitors, especially newcomers which will increase the supply of the good
and depress the price.
In the case of a monopolistic competition, there are low barriers to entry into the
market, particularly in the long run, as such there will also be many firms in the
market, albeit a fewer amount than in perfect competition. However, unlike a firm in
perfect competition, the product is not homogeneous, with each product being a
close but imperfect substitute of the other. As such the demand (AR) curve is almost,
but not perfectly price elastic. This means that AR will not be equal to MR, and as
such, the firm may be able to charge a price higher than the MC at a given output.
The low barriers to entry, however, also mean that when firms in monopolistic
competition do make supernormal profits in the short run, newcomers may enter to

erode the market share and reduce the profits to merely normal profits. As such, in
the long-run firms will also need to maximise profits in order to avoid making losses,
and will only produce at the output
MC=MR.

Because of the large number of firms in the market, each firm will only have a small
market share, the action of a single firm will thus not have that large an impact on the
rest of the firms, unlike with monopolies or oligopolies. As such, firms in a
monopolistic competition will make its pricing and output decisions independent of its
competition.
That said, there is a tendency for firms in a monopolistic competition to act like
localised oligopolies, especially if these firms are located in the vicinity of one
another. This may result in short-term price-wars.
On the other hand, for a market where barriers to entry are large, there are
fewer firms in the market, and firms will find it relatively harder to enter the market,
as in the case of a monopoly or oligopoly. Each firm will thus have a non-negligible

market share which grants them the ability to set prices. This means that the
average revenue curve of the firm will be relatively price inelastic, so the firm will be
able to charge a price beyond the marginal cost at the given output to make
supernormal profits in the short run. This supernormal profit may also be retained in
the long run due to the presence of high barriers to entry that prevent the entry of
new firms that may erode the market share and thus the profits of the incumbent
firms.
Because of their ability to make supernormal profits, they may make pricing
decisions in the short run that cater to other alternative aims of the firm such as
maximising the revenue of the firm, competitive pricing strategies, or pursue other
managerial objectives. Additionally, because they possess significant market power,
they will have the ability to practice price discrimination without losing too many
consumers to their rivals. This is even more prevalent in a monopoly as consumers
will not be able to switch to other producers in the first place.
However, monopolies and oligopolies differ in how much reliance they have to place
on rivals or the lack thereof.
For a firm in an oligopoly, pricing and output decisions must be with the
consideration of other rivals, for fear that any changes will lead to a particularly
ruinous price war. This is because the barriers to entry have created a situation in
which each firm has a sizeable market share, and changes in prices or output will
impact the market shares of other firms, threatening their profits.