Barriers to Entry and Exit

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    A barrier to entry is a factor blocking or disincentivizing a new firm from entering a market.

    Barriers to entry allow incumbent (existing) firms to block the entry of new firms, maintain their own market share/power and keep earning super-normal profit.

    Many entry barriers exist:

    1) Technological Barriers.

    A potential entrant may not have the knowledge or access to resources necessary to enter an industry.

    2) Average Costs (Economies of Scale).

    A market’s incumbent firms may have large economies of scale and very low AC. Any new firm would not experience economies of scale (because economies of scale occur in the long-run, not as soon as the firm enters the market), so a new firm’s costs may be too high for it to make a profit. So the potential firm is disincentivized from entering the industry.

    3) Advertising.

    Advertising creates a brand image, brand loyalty and makes demand for a firm’s good more inelastic. A potential entrant may need to spend a lot on advertising to compete with incumbent firms, and these higher costs disincentives the firm from entering the market.

    4) Start-Up Costs.

    An industry may require a high start-up cost for a new firm (a runway for an airline). The higher the start-up cost, the more expensive it is to enter the industry.

    5) Legal Barriers.

    After a new good (idea) is invented it can be given a patent, Intellectual Property Right (IPR) or copyright. A patent gives a firm legal protection by the government to be the exclusive producer of a good for a number of years. Only the patent holder can produce the patented good. No new firm can enter the market and produce the same good.

    6) Quotas and Tariffs.

    A new firm cannot enter a market if it is blocked by a quota, the firm requires a license to produce. An international tariff may also block foreign firms entering a domestic market.

    7) Limit Pricing.

    Limit pricing occurs when an incumbent firm sets a price so low that they earn normal profit (or low super-normal profit) to make rivals make a loss (because they are not as efficient). A potential firm will not enter the industry if they expect to make a loss.8) Predatory Pricing.

    An incumbent firm may use predatory pricing to price below their own AC curve so that both they and rivals make a loss. Potential firms will not enter the industry if they think they will make a loss. The incumbent firm must be deep-pocketed to do this, they must have the funds to be able to make losses. However, the losses cannot be sustained in the long-run, this tactic is a short-run tactic only. Also, predatory pricing is illegal, so the incumbent firm must avoid being caught by authorities.

    A barrier to exit is a factor blocking an existing firm from leaving a market quickly and at a low cost. A major exit barrier is sunk cost. Sunk costs are costs that cannot be recovered upon exiting a market. Basically sunk costs are costs associated with advertising and cancelling contracts with suppliers, workers and buyers. The higher are sunk costs, the higher the costs of failure and the more risky it is to enter the industry. An exit barrier therefore acts as an entry barrier because it disincentivizes firms from entering a market.

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