Barriers to Entry and Exit

Barriers to Entry

Barriers to Entry

Factors that prevent or make it difficult for new firms to enter a market - protects monopoly power and maintain SNP in the long run and increase producer surplus.

What are the two types of Barriers?

• Natural Barrier - feature of an industry which exists without any strategic action being taken by the existing firms.

• Artificial Barrier - one which has been strategically placed by the incumbent firm.

Natural Barriers to Entry

• Start-up Costs – some industries have extremely high startup costs which new entrants may not be able to finance e.g. Water companies.

• Cost Advantages (Economies of Scale) - large firms will be able to charge lower prices for their products because they will have a lower average cost.

• First mover in the market – establishing first gives a big advantage. It is very difficult for any new firm to compete with the first mover privileges that Google has. 

Artificial Barriers to Entry

• Patent – an artificial barrier where a firm has taken out legal protection against any other rival copying their idea or product. 

• Limit Pricing – an artificial barrier where a dominant firm will charge a very low price in the short term to remove any new entrants in the market. 

• Predatory Pricing – an incumbent firm prevents people from entering by charging a price lower than AC – artificial barrier – it is illegal. 

• Advertising and marketing – advertising can be very expensive - new entrant may not be able to compete with the level of advertising required to raise awareness of the product. 

• Research and development – R&D is a very expensive activity which does not necessarily bring any returns. A large incumbent firm may be able to absorb these costs. It also means that any new firm may find its products out of date very quickly if larger firms are bringing out new products.  

• Vertical Integration – occurs when a firm has control over the supply and distribution of the goods. For example, oil companies can keep the price of petrol very high to discourage new petrol retailers – if a new firm wants to enter the retail petrol market, it will have to buy petrol from one of the big oil companies, who can set a high price thereby discouraging entry into the petrol market. 

What are Sunk Costs?

Sunk costs – cannot be recovered if a business decides to leave and industry (barrier to exit). 

• Capital inputs that are specific to an industry and which have little or no resale value. 

• Revenue spent on advertising, marketing and research and development projects which cannot be carried forward into another market or industry.