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11.6 WHY DO MONOPOLY MARKETS EXIST? 473
If one firm can serve a market at lower total cost than two or more firms, we
would expect that the market would eventually become monopolized. This is what
happened in the satellite broadcasting market in the United Kingdom. Two firms en-
tered that market in the early 1990s: British Satellite Broadcasting and Sky Television.
But with both firms in the market, neither could make a profit. In fact, at one point
both companies were losing more than $1 million a day. Eventually, the two firms
merged, forming the satellite television monopolist BSkyB, which, since the merger,
has become profitable.
The analysis in Figure 11.17 implies two important points about natural monop-
oly markets. First, a necessary condition for natural monopoly is that the average cost
curve must decrease with output over some range. That is, natural monopoly markets
must involve economies of scale. In the example of satellite broadcasting, the fixed
cost of the satellite and its associated infrastructure gives rise to significant economies
of scale. Second, whether a market is a natural monopoly depends not only on tech-
nological conditions (the shape of the AC curve) but also on demand conditions. A
market might be a natural monopoly when demand is low but not when demand is
high. This would explain why the satellite broadcasting market in the United
Kingdom contains just one firm (BSkyB), while the much larger U.S. market can ac-
commodate several competitors.

BARRIERS TO ENTRY

A natural monopoly is an example of a more general phenomenon known as barriers barriers to entry
to entry. Barriers to entry are factors that allow an incumbent firm to earn positive Factors that allow an in-
economic profits, while at the same time making it unprofitable for newcomers to cumbent firm to earn posi-
enter the industry. Perfectly competitive markets have no barriers to entry: When in- tive economic profits while
cumbent firms earn positive profits, new firms enter the industry, driving profits to making it unprofitable
for newcomers to enter
zero. But barriers to entry are essential for a firm to remain a monopolist. Without the industry.
the protection of barriers to entry, a monopoly or cartel that earned positive economic
profits would attract new market entry, and competition would then dissipate indus-
try profit.
Barriers to entry can be structural, legal, or strategic. Structural barriers to structural barriers to
entry exist when incumbent firms have cost or marketing advantages that would make entry Barriers to entry
it unattractive for a new firm to enter the industry and compete against them. The in- that exist when incumbent
teraction of economies of scale and market demand that gives rise to a natural monop- firms have cost or demand
oly market is an example of a structural barrier to entry. The Internet auction market advantages that would
make it unattractive
provides an example of another type of structural entry barrier, this one based on pos- for a new firm to enter
itive network externalities. As noted in Chapter 5, positive network externalities arise the industry.
when a firm’s product is more attractive to a given consumer the more the product is
used by other consumers. The auction site of market leader eBay is attractive to auc-
tion buyers because there are so many items offered for sale and there are often several
sellers of the same item. Auction sellers like eBay because there are so many buyers.
The sheer volume of transactions on eBay, in and of itself, is an important part of
eBay’s appeal. This network externality creates a significant barrier to entry. A new-
comer seeking to establish its own Internet auction site (to make money, as eBay does,
through commissions on transactions) would face an enormous challenge: Lacking
the critical mass that eBay possesses, it would simply not be as attractive a site. This
barrier to entry explains why some very savvy Internet companies, including
Amazon.com and Yahoo, found it difficult to establish their own auction sites to com-
pete against eBay.