Market Performance under Entry – Limiting Behavior

How does the presence actual or potential of a competitive fringe affect market performance? How much control over price is a dominant firm able to exercise, compared with competition and monopoly?

The answer, of course, is, “it depends” as it is to almost all question in economics. In most of the classes that use this text book, however, you will not get much credit for that answer unless you are able to explain what market performance depends on. It is no that topic that we now turn.

First, consider the static limit price model. If entry is blockaded – if the dominant firm can charge the monopoly price and if it is still not profitable for new firms to come into the market – we are back to the basic monopoly model of chapter 2. The only limit on the exercise of market power is the price elasticity of demand: if the monopolist raises the market price, some consumers will go away.

If there are some entry costs but entry is not blockaded, two possibilities arise. If entry costs are sufficiently great, a dominant firm will be able to preclude entry with only a moderate expansion of output above the monopoly level and only a moderate reduction in price below the monopoly level. The dominant firm will exercise some market power, but not as much as a monopolist. It will charge the highest price it can, without inducing entry. This possibility of entry will improve market performance, but the dominant firm will continue to exercise some market power.