chapter 15: entry, exit, and long run profitability

Accounting profit

total revenue - explicit financial costs, tracks money that goes in and out of the business

Average cost

cost per unit (firms total costs /quantity produced)

Average revenue

revenue per unit (total revenue/ quantity supplied), equal to the price if you charge everyone the same price

Barriers to entry

obstacles that make it difficult for new firms to enter a market

Economic profit

total revenue - explicit financial costs - implicit opportunity costs, considers opportunity costs

Free entry

when there are no factors making it particularly difficult or costly for a business to enter or exit an industry

Long run

horizon over which you or your rivals may expand or contract production capacity and new rival smay enter the market or existing firms may exit

Profit margin

profits per unit sold, average revenue - average cost

rational rule for entry

you should enter a market if you expect to earn a positive economic profit, which occurs when the price exceeds your average cost

Rational rule for exit

exit the market if you expect to earn a negative economic profit, which occurs if the price is less than your average costs

Short run

horizon over which the production capacity and the number and type of competitors you face cannot change

Switching costs

any impediment that makes it costly for customers to switch to buying from another business

when a new competitor enters

existing firms lose customers, the firms demand curve shifts left (you sell a smaller quantity), the demand also becomes flatter, existing firms lose market power (you lower your price)

when an existing competitor exits

existing firms gain customers, the firms demand curve shifts right (you sell a larger quantity), the demand also becomes steeper, existing firms gain market power (you raise your price)

entry dynamic

economic profits are positive —> new rivals enter —> market share and market power of incumbent suppliers decreases —> quantity and price decrease —> economic profits decline

exit dynamic

economic profits are negative —> some rivals exit —> market share and market power of continuing suppliers increase —> quantity and price increase —> economic profits increase

when do feedback processes end

when profits are zero —> long run equilibrium

long run equilibrium

with free entry/exit, firms make zero economic profit, price = average cost

strategies that create barriers to entry

demand side strategies that create customer lock-in

supply side strategies to develop unique cost advantages

regulatory strategies that enlist government policy to prevent entry

entry deterrence strategies to scare off potential rivals

demand side strategies that create customer lock in

use switching costs, keep customers loyal, develop network effects

supply side strategies to develop unique cost advantages

mass production or scale economies, develop cost advantages through R&D, develop relationships with suppliers to get better prices, limit access to key inputs for new rivals

regulatory strategies that enlist government policy to prevent entry

patents, regulations that make entry difficult, government licenses

Entry deterrence strategies to scare off potential rivals

build excess capacity, show your financial resources, brand proliferation, develop a reputation for fighting