Study notes

Barriers to Entry and Exit

Barriers to entry are designed to block potential entrants from entering a market profitably.

Cost of introducing a new product into the pharmaceutical industry

They seek to protect the power of existing firms and maintain supernormal profits and increase producer surplus.

Barriers make a market less contestable - they determine the extent to which well-established firms can price above marginal and average cost in the long run.

George Stigler defined an entry barrier as “A cost of producing which must be borne by a firm which seeks to enter an industry but is not borne by businesses already in the industry".

George Bain defined entry barriers as “The extent to which established firms elevate their selling prices above average cost without inducing rivals to enter an industry".

Cost advantages and entry barriers

  • The Bain interpretation of entry barriers emphasises the asymmetry in costs that often exists between the incumbent firm and the potential entrant
  • If existing businesses have managed to exploit economies of scale and developed a cost advantage, they can cut prices if and when new suppliers enter the market.
  • This is a move away from short-run profit maximisation – but it is designed to inflict losses on new firms and protect a dominant position in the long run.
  • The monopolist can revert back to profit maximization once a new entrant has left
Examples of barriers to entry

Structural, Strategic and Statutory Entry Barriers

  • Structural barriers ('innocent' entry barriers) – arising from differences in production costs
  • Strategic barriers such as different pricing policies
  • Statutory barriers – these are entry barriers given force of law (e.g. patent protection of franchises such as the National Lottery or television and radio broadcasting licences)

Theory of Early Mover or First Mover Advantage

Sometimes there are sizeable advantages to being first into a market – first-movers can establish themselves, build a customer base and make life difficult for firms who arrive later on the scene.

First mover advantage can prove to be only a temporary benefit to businesses that are first to gain commercially from a new market opportunity

Examples of strategic entry barriers in markets

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