8.3 Barriers to Entry and Exit Flashcards
Barriers to Entry: Economies of Scale (Natural Monopoly)
Economies of Scale (Natural Monopoly). A firm experiencing huge economies of scale will experience significantly lower costs of production than a new firm. As a new firm enters the market they could be easily priced out and not compete with the large incumbent, lacking the ability to grow to a similar size quickly. As a consequence, fewer firms enter the market and competition is restricted.
Barriers to Entry: High Start Up Costs
High start up costs. High start up costs act as a deterrent for new firms entering a market deciding instead to set up elsewhere where the initial risks are much lower. As a consequence, fewer firms enter the market and competition is restricted.
Barriers to Entry: High Sunk Costs
High sunk costs. Sunk costs are costs that are not recoverable when a firm leaves the market such as highly specialist machinery and advertising. Firms knowing that leaving the industry will result in costs that are not recoverable may be enough of a deterrent not the enter the market in the first place consequently reducing competition in the market.
Barriers to Entry: Legal Barriers
Legal barriers. This could include for example, patents, strict health and safety regulation, planning regulation, labour laws, environmental regulation and product standards. The higher the legal barriers, the lower the incentives to enter the market for firms where costs of production and uncertainty can be high. As a consequence, fewer firms enter the market and competition is restricted.
Barriers to Entry: Strategic barriers
Strategic barriers. Examples include predatory pricing, where prices are charged lower than the profit maximising price (maybe a loss making price) in order to drive out existing competition and limit pricing, where prices are charged at normal profit levels to take away the incentive for new entry into the market. Strategic actions could also include heavy advertising or flooding the market with goods or services to establish a dominant position over a new start up firm. The existence or threat of such strategies might be enough to detract firms from entering the market thus restricting competition.
Barriers to Entry: Brand Loyalty
Brand Loyalty. Entering a market where consumers are loyal to big brands is risky. The existence of big firms with large marketing budgets may detract new firms entering the market who cannot compete on marketing spend with the large incumbent firms in order to create brand loyalty or awareness for their own product. The end result is fewer firms entering the market and restricted competition.
Barriers to Exit: Redundacy Costs
Redundancy Costs. Upon leaving an industry, if a firm has to contractually pay large redundancy packages for its workers, it may prevent a firm leaving an industry minimising their costs by continuing in production instead.
Barriers to Exit: Sale of Assets
Sale of Assets. If a firm owns assets that they cannot agree a good price for upon leaving the market, i.e. a price offered is far below the price the firm paid in the first place, they may continue producing as a way of minimising their costs.
Barriers to Exit: Contractual Agreements
Contractual Agreements. If a firm has contractual agreements for gas, electricity, water etc. there may be a large cancellation fees applied with early contract termination, reducing the viability for a firm to leave the industry, waiting instead until the contracts have ended before leaving.
