Fixed Costs, Sunk Costs, Entry Barriers, and Sustainability of Monopoly

Abstract

This paper shows that (i) fixed costs of sufficient magnitude assure the existence of a vector of sustainable prices for the products of a natural monopolist-prices making him invulnerable against entry; (ii) nevertheless, fixed costs do not constitute barriers to entry; that is, they need not have undesirable welfare consequences; (iii) indeed, in market forms that we call perfectly contestable large fixed costs are completely compatible with many desirable attributes of competitive equilibrium; (iv) sunk costs do, however, constitute barriers to entry; and (v) finally, the profit and welfare consequences of entry barriers are described formally. In this paper it is shown that (i) fixed costs of sufficient magnitude assure the existence of a vector of sustainable prices-a set of product prices that make a (natural) monopolist invulnerable against successful entry; (ii) nevertheless, costs that are truly fixed do not constitute barriers to entry; that is, they do not have the welfare consequences normally attributed to barriers to entry; (iii) indeed, there are markets of a form (which we call perfectly contestable markets, and whose properties may be approximated in practice) in which large fixed costs are completely compatible with many if not most of the desirable attributes of competitive equilibrium; (iv) sunk costs do, however, constitute barriers to entry; and (v) finally, the resource allocation problems that stem from fixed costs are formally identical with those that accompany public goods-both their sources and their character are the same. Thus, the rationale for public supply of public goods may be no different from that pertaining to nationalization of natural monopolies.