Market Structures and Barriers to Entry

Study Notes

Barriers to Entry and Exit

Barriers to entry block potential new entrants from profitably entering a market.
Barriers to exit obstruct firms from leaving an industry, creating challenges for businesses that wish to withdraw.

Contestable Markets

Contestable markets feature low barriers to entry and exit, where the cost structure for new firms equals that of incumbent firms.
Perfectly contestable markets do not exist in reality; real-world markets vary in degrees of contestability.

Sunk Costs

Sunk costs are non-recoverable expenses if a business exits an industry, discouraging firms from leaving.
Examples include industry-specific capital inputs and non-transferable marketing expenditures.

Examples of Barriers to Entry

Patents: Provide exclusive rights to inventors, limiting competition.
Limit-pricing: Established firms may lower prices to levels that push new entrants into losses.
Cost advantages: Incumbent firms benefit from operational experience, allowing for lower pricing and competitive flexibility.
Advertising and marketing: Strong brand loyalty makes market entry costly for newcomers, especially in industries like cosmetics and automotive.
R&D Expenditure: High investment in research and development can deter new entrants due to competitive advantages gained by existing firms.
Presence of Sunk Costs: High initial costs and the risk of unrecoverable investments reduce the attractiveness of market entry.
International Trade Restrictions: Tariffs and quotas can protect domestic industries, creating barriers for foreign competitors.
Economies of Scale: Larger firms lower production costs, making it challenging for smaller entrants to compete effectively.

Examples of Barriers to Exit

Asset-write-offs: Costs related to the disposal of fixed assets, stocks, and brand goodwill can discourage exit.
Closure Costs: Includes redundancy payments and penalties linked to terminating leases and contracts.
Loss of Business Reputation: Exiting can harm future consumer goodwill and reputation in the industry.
Market Downturn Perception: Temporary downturns may tempt firms to stay in the market, hoping for recovery rather than losing investments.
Sunk Costs: Non-recoverable costs act as a deterrent against leaving the market, entrenching firms in less favorable conditions.

Goodwill

Goodwill refers to a business's established reputation, seen as a quantifiable asset when evaluating its sale price.

Hit-and-Run Entry

Describes a strategy where firms temporarily enter a contestable market to capture short-term profits before rapidly exiting.

Description

This quiz delves into the concepts of barriers to entry and exit in market structures. It covers contestable markets, the significance of sunk costs, and various examples illustrating how incumbents maintain competitive advantages. Test your understanding of these essential economic principles.