1. What do barriers to entry have to do with competition?

Remember Joe's Gourmet Hamburgers from the last chapter? Let's think about Joe's economic profits, competition, and entry into the market. When Joe first opened his restaurant, nobody else in his town made gourmet hamburgers. Gourmet hamburgers turned out to be very popular, and Joe could charge a high price for them and make a very nice economic profit (for Joe).

Pretty soon other restaurant owners noticed Joe's high profits and started planning to open other restaurants in competition with Joe. Remember from our study of demand and supply that an increase in the number of sellers causes the price to go down. If new competitors opened restaurants to compete with Joe, his economic profits would eventually disappear.

If Joe could create some barrier that prevented other people from opening competing restaurants, Joe could keep on getting economic profits into the future. If Joe could prevent entry, he would also cause a deadweight loss.

2. How do firms create profits?

Firms create profits by doing something that others aren't doing. This may be making a unique product, like Joe's Gourmet Hamburgers, or using a better production method. It can also come from being more successful than others at convincing buyers that your product is in some way superior to competing products.

3. How do firms keep profits?

Firms need to create barriers to entry to keep economic profits in the long run. A firm like Joe's Gourmet Hamburgers can use a variety of methods to build barriers to entry. Advertising could convince consumers that Joe's hamburgers are better than other hamburgers. If there are economies of scale in making and selling hamburgers, and Joe's economies of scale were much larger than other competitors', Joe would have a cost advantage over other competitors and could sell his hamburgers at a lower price and still make economic profits.