The oligopolistic market structure contains a few firms who may collude to earn monopoly profits by raising market price to a level well above their long – run average cost. These profits that emerge from cooperation of oligopoly firms in the short – run, may well continue in the long – run also if only entry of new firms into industry is effectively prevented. If this does not happen, the long – run oligopoly market may be no different from monopolistic competition where entry barriers are essential for persistence of long – run oligopoly profits. Some such barriers may exist in the following forms:
An oligopolist firm may produce a wide range of differentiated products rather than a single homogenous product. Each producer may alter, modify or enhance some features of its product to meet a wide variety of tastes, preferences and purchasing power of the large range of buyers in the market.
These days, advertising with its huge cost, has become an important entry barrier for the new firm firms. The existing firms have established their brands through massive publicity in electronic media, print media and other means that involves budgets and massive expenses. Such large publicity campaigns have created some brand image of the product in consumers’ mind so much so that some brand have become so etched up in our mind however is that we inadvertently call every washing powder by the name of surf, which however is only the brand name. To break this mental setup, the new firms may have to go in for publicity at a scale which may not be economically viable for the scale of operations that they intend to undertake. Thus, advertising acts as a patent barrier to entry of new firms in the present – day oligopolist market dominated by a few big firms with their large number of brands selling in the market.
A contestable market is one where entry is easy and therefore, even if there is no actual entry, the firms take into account potential entry while making their price and output decisions. Entry into the industry which has well established big firms existing with a large brand of products is not very easy. It may involve a huge cost to build up large plant for producing a wide variety of differentiated products and massive advertisement expenditure to ensure sales of these products. These may be called sunk costs of entry as these expenses cannot be recovered if the firm leaves the industry subsequently. Thus, these circumstances make the entry difficult and market uncontestable posing no danger of actual or potential entry of firms.
The larger the sunk costs, the bigger and long lasting are the profits. Contestability thus acts as a force to limit profits. The fear of new firms entering easily may make the existing firms fix low prices and earn less profit. Contestability of the market is thus another way of saying that fear of entry of new firms, wherever possible, would act as a disincentive to the producers to charge higher prices and make bigger profits.SUBMIT ASSIGNMENT NOW!