key term - Barriers to Entry and Exit

Definition

Barriers to entry and exit are obstacles that make it difficult for new firms to enter an industry or for existing firms to leave it. These barriers can take various forms, such as high startup costs, strict regulations, or strong brand loyalty among consumers. Understanding these barriers is essential when analyzing market structures, particularly in perfect competition, where low barriers allow many firms to enter and exit freely based on market conditions.

5 Must Know Facts For Your Next Test

1. In perfect competition, low barriers to entry mean that new firms can easily join the market when they see profit opportunities.
2. High barriers to entry can lead to monopolies, reducing consumer choice and potentially raising prices.
3. Exit barriers can include sunk costs, contractual obligations, and emotional attachments, making it hard for firms to leave unprofitable markets.
4. The existence of barriers affects the long-run supply curve in perfect competition, where firms can enter or exit until they earn zero economic profit.
5. Governments may implement regulations that create barriers to entry, affecting the overall competitiveness of a market.

Review Questions

• How do barriers to entry impact the number of firms in a perfectly competitive market?
  • In a perfectly competitive market, low barriers to entry allow numerous firms to enter when they observe profitable conditions. This influx leads to increased competition, which helps drive prices down toward the marginal cost of production. Consequently, if profits exist in the short run, more firms will join the market until only normal profits remain in the long run.
• What are some examples of barriers to exit that might affect a firm's decision to leave a market?
  • Barriers to exit include factors like high sunk costs associated with investments that cannot be recovered, ongoing contractual obligations that tie a firm to its operations, and emotional ties or reputational concerns that make it difficult for owners to shut down their business. These factors can prevent firms from exiting unprofitable markets even when it would be economically beneficial.
• Evaluate how government regulation can create barriers to entry and influence market competition.
  • Government regulation can establish significant barriers to entry through licensing requirements, safety standards, or environmental regulations that new firms must meet before entering a market. While these regulations can protect consumers and promote public welfare, they can also stifle competition by making it difficult for smaller or new businesses to compete against established players. This dynamic can lead to monopolistic behaviors where few firms dominate the market, potentially resulting in higher prices and less innovation.

Related terms

Perfect Competition:

A market structure characterized by a large number of small firms, homogeneous products, and no barriers to entry or exit, leading to efficient resource allocation.

Monopoly:

A market structure where a single firm dominates the entire market, often due to high barriers to entry that prevent other firms from competing.

Market Structure:

The organizational and competitive characteristics of a market, which include the number of firms, type of products offered, and barriers to entry and exit.