Barriers to Market Entry and Exit

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  • Created by: Frances
  • Created on: 31-05-13 11:35

Barriers to entry

Definition: Prevent potential competitors from entering a market

  • Economies of scale. In some industries they are very large. This is a barrier to entry as any new firm entering the market is likely to be very small therefore have higher average costs than existing producers. In natural monopolies economies of scale are so great it is unprofitable for more than one firm to exist in an industry.
  • Pricing strategies. Limit pricing - pricing at a level low enough to discourage entry of new firms, that is, ensuring that the price of a good is below that which a new firm entering the industry would be able to sustain. This exploits economies of scale that an incumbent firm has. In the short run, both limit and predatory pricing will seem to benefit the consumer by providing them with lower prices. However, when the firm has managed to drive out rival firms out of the industry and gained monopoly power, it will be able to raise prices, reducing th consumer surplus and reducing consumer choice.
  • Asymmetric information. If existing firms have better information about the way the industry works then it will take expensive time for new entrants to acquire this knowledge. It is a reality in many markets.
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Barriers to entry cont.

Legal restrictions

  • Patents. Exclusive production rights for a given period of time to inventor of certain products. For exammple pharmaceutical companies. They are guaranteed returns on their enormous research costs. Drugs have a 20 year patent. When drugs are on patent they are very expensive for health authorities.
  • Legal monopoly. For example the Post Office. Until recently it was a legal monopoly. Now has been eroded away since 2006. It still has licence to provide universal postal service - will deliever letters anywhere in the Uk for the same price. Postal market now liberalised. Allows private firms to apply for licence to operate within universal postal service.

Sunk costs. Sunk costs are unrecoverable past expenditures. These should not normally be taken into account when determining whether to continue a project or abandon it, because they cannot be recovered either way. For example advertising. If existing firms spend heavily on advertising, new firms will have to do the same to compete on equal terms. Advertising drives up the average costs. However, advertising is needed within an industry as it will increase brand loyality.

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Barriers to exit

Definition: Are barriers which prevent a firm from leaving an industry quickly and at little cost.

In most industries, barriers to exit are low. Barriers to exit include the cost and time of making employees redundant, selling premises and stock or notifying customers and suppliers. Barriers to exit increase when employment laws make it more difficult to make staff redundant. However, there may be other barriers to exit. A firm may be locked into a contract to supply another firm which, if it breaks, it will have to pay a large penalty. Or it may have leased premises where the individual owner has to continue paying the lease even if the business is closed down. In these circumstances, the firm may make a smaller loss by staying in the industry than by closing it.

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