The concept of competition:
Bain distinguishes between two types of competition, actual competition between established firms, and potential competition arising from the potential entry of firms outside the industry.
Actual competition is probably of high importance as a regulator of business activity especially in oligopolistic markets. Existing firms act continuously under the feeling of interdependence with their actual competitors.
However, the threat of potential entry is also an important determinant of the pricing policies of firms. There is a double form of recognized interdependence: interdependence among established firms, and interdependence between established firms and potential entrants.
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In the traditional theory of pure competition and monopolistic competition entry is discussed explicitly. In both models entry is treated as actual entry, whose effects on equilibrium are determinate, and as a long-run phenomenon, in the sense that entry can take place only in the long run. The latter implies that entry comes from completely new firms, starting from scratch. The former implies no consideration of the effects on current price-output decisions of the threat arising from potential entrants.
Both models assume that entry is free (in the sense of there being no legal restrictions) and easy in the long run (in the sense that there are no insurmountable barriers to entry). The consequence of the assumption of free entry in pure competition is that in the long run equilibrium of each firm and of the industry is attained at and costs are at a minimum.
P = LAC = LMC
The consequence of the assumption of free entry in a monopolistic market in the long run is that equilibrium is reached with the tangency solution but costs are not at a minimum, because excess capacity is a necessary consequence of the falling demand curve.
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P = LAC and P > LMC
In oligopolistic markets, however, conventional theory has in general been inexplicit, cryptic or silent. The naive oligopoly models of Cournot, Bertrand, Edge-worth and Chamberlin are closed models, not allowing for entry the number of firms in the model is assumed constant. The models of collusive solutions are also closed models. Cartels are inherently unstable and they break down once entry is allowed, while in the traditional models of price leadership the entrant is usually assumed to be a small firm which follows the leader.
Fellner was the first writer to mention that the threat of potential entry is one of the reasons why the collusive oligopolists do not charge the monopoly price. Entry considerations and their importance in pricingpolicies appeared fairly recently in the theory of the firm.
The concept of entry in Bain‘s theory:
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Bain considers entry as the establishment of a new firm which builds or introduces new productive capacity that was not used for production in the industry prior to the establishment of the new firm. Thus for Bain entry involves the setting up of a new firm and the addition of new capacity in the industry.
Bain explicitly excludes from his entry concept:
(a) The take-over of an existing firm by some other firm, which constitutes change in ownership;
(b) The expansion of capacity by an established firm;
(c) Cross-entry, that is, entry by a firm already established in another industry, which adds the product of this industry to its line of products.