Quiz 9: Market Failure and Externalities


a.Patent right: Patent is a kind of intellectual property rights, given by the government to the inventor for a particular period of time. In U.S., patent right is given for 20 years. Patent rights legally protect the patentee from others reproducing, using, selling, and distributing the patented invention to others without his/her permission. b.Legal restriction: Patent is a kind of intellectual property rights, given by the government to impose legal restrictions that prevent entry in to an industry. c.Monopoly: Natural monopoly: Natural monopoly refers to the firm that has entire market share and produces at lower cost of production. If there is a competition, then it leads to increase in the cost of production. Natural monopoly can be achieved through public ownership and public regulation that regulates the price of monopoly firm. Since the firm controls 100% market and has lower unit cost, it is considered as n atural monopoly. d.Barrier entry: Barriers to entry refers that an existing firm restricts the new firm to enter the business through controls such as essential or non reproducible resource , low cost of production, and low price.

Economies of scale: Economies of scale refer to a fall in the cost of production due to an increase in the level of output production. Economies of scale provide barrier to entry : When a firm's cost of production decreases throughout its production process in the long-run, then it enjoys the economies of scale. The economies of scale may occur even when the firm run in profits by investing on the labor, for advertising and other machinery. Mostly, the economies of scale provide barrier to entry to the small firms. Some examples are given below: - With the increase in demand for the skilled workers, the existing firms enjoy economies of scale thereby, increasing its production. Therefore, this demand for the skilled labor is the entry barrier for the small companies to enter into the new market. - The advertising costs in the electronic media involved would make the firm run in profits by reaching more customers within less time. And eventually leads to economies of scale. But, this would make the new companies frighten, with the increasing costs of advertising per second pulse, to invest huge amount of capital. The new firms also cannot enter the market, since its cost of production is higher than the low-cost firms. Hence, economies of scale provide barrier to entry.

Cartel: Cartel refers to the situation where the producers join together and act as a single firm to maintain a higher price.Maintaining the price: The DB Company controlled the supply of rough diamond throughout the world. When there is a higher supply, then DB Company buys the excess supply of the rough diamond from the market with the intention to maintain the higher price for the diamond. Since the DB Company controls the supply of rough diamond, it is able to fix and maintain the higher price.Losing the control: DB Company maintains the higher price by controlling the supply of essential resource of rough diamond. When the new firms from different countries supply the rough diamond in large quantities, then the ability of DB Company's control over the supply of rough diamond would weaken. Hence, DB Company lost the ability to maintain the higher price.

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