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The Immense Importance of Freedom of Entry

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In my latest column for AIER, I argue that the best protection against monopoly power is freedom of entry. If entrepreneurs are free to enter and to exit industries, there is no need for antitrust enforcement [2]. A slice:

Yet no amount of training and skill, or even a Nobel Prize, as an economist equips anyone with God-like knowledge of the practically infinite number of ways that businesses might devise, or stumble upon, to make their products more attractive to consumers. No one has, has ever had, or ever will have such knowledge. A key reason for this reality is that competition is, as F.A. Hayek dubbed it, “a discovery procedure.” [3]

Consumers, it’s true, want to pay prices as low as possible. But low prices are not all that consumers care about. (If low prices were all that consumers care about, everyone would buy used cars and eat only hamburger; no one would buy a new car or eat steak.) Consumers care also about product quality, product selection, product styling, product image, product availability, and the nature of the experience of purchasing the product. Also, of course, consumers must know about a product’s existence if they are to have any demand for it at all. And consumers are willing to pay higher prices in exchange for sufficiently valuable improvements in any of these features.

Each of these features of a product must be attended to by producers. Such attention comes in the form of experiments with different product styles, with different means of distribution, and with different ways of bringing the product, its quality, and its price to consumers’ attention. Cutting prices is obviously not the only – and very often it’s not the best – means of increasing consumer satisfaction.

Economic competition, therefore, consists not merely of price cutting. It consists also of non-price competition. It consists of firms attempting to lower their costs of producing each unit of output by, for example–

  • increasing the scale of their operations
  • merging with some suppliers of inputs
  • entering into long-term contracts with distributors of their outputs

Of course, firms that successfully lower their costs of production pass along to consumers at least some of these cost savings in the form of lower prices – price cuts being, obviously, an easy means of gaining more business.

Non-price competition consists also of experiments with measures to make non-price aspects of outputs more attractive to consumers, measures such as –

  • changing the number and kinds of product features and amenities that are bundled together as ‘the’ product
  • exercising tighter control over franchisees to better ensure that customers consistently receive good service
  • offering a new product line

Because there are countless different ways for businesses to cut costs – ways that differ across industries and firms, and change with the times – and also countless different ways, other than cutting prices, for business to make their outputs more attractive to buyers, knowledge of what are currently the ‘best’ ways of competing for customers cannot be divined with abstract theorizing. The best ways are discovered only when entrepreneurs actually experiment in competitive markets.

By the nature of experiments, though, outcomes aren’t preordained. Some entrepreneurial experiments will prove successful, meaning that consumers will spend enough money on the results to ‘prove’ these experiments to be worthwhile. Other experiments, in contrast, will fail. Those entrepreneurs who, whether through acumen or dumb luck, conduct successful experiments will earn unusually high profits. These high profits will attract other entrepreneurs to mimic as closely as possible the successful experiments. The high profits reaped by the successful experimenters will thus be driven down as the copycats push prices downward and attract some consumer demand.