Barriers to Entry

Definition

Barriers to entry are obstacles that make it difficult or costly for new firms to enter a particular market or industry. These barriers can give existing firms a competitive advantage and allow them to maintain higher prices and profits.

5 Must Know Facts For Your Next Test

1. Barriers to entry can allow existing firms to charge higher prices and earn greater profits without the threat of new competition.
2. Economies of scale, where larger firms have lower average costs, can create a barrier to entry for smaller firms that cannot match the cost advantages.
3. Government regulations, such as licenses, permits, or quotas, can serve as barriers to entry and limit the number of firms in a market.
4. Proprietary technology, brand loyalty, or access to distribution channels can also act as barriers to entry for new firms.
5. High initial investment costs, or sunk costs, can deter new firms from entering a market, as they may not be able to recoup these costs.

Review Questions

• Explain how barriers to entry relate to entry and exit decisions in the long run for a perfectly competitive market.
  • In a perfectly competitive market, barriers to entry play a crucial role in the long-run entry and exit decisions of firms. When there are low barriers to entry, new firms can easily enter the market, driving down prices and profits for existing firms. Conversely, high barriers to entry can protect existing firms from new competition, allowing them to maintain higher prices and profits in the long run. The presence or absence of barriers to entry can thus determine whether a market remains perfectly competitive or becomes dominated by a few large firms.
• Describe how barriers to entry affect the efficiency of a perfectly competitive market.
  • In a perfectly competitive market, the absence of barriers to entry ensures that resources are allocated efficiently, as new firms can enter the market and drive prices down to the level of minimum average cost. However, the presence of significant barriers to entry can lead to a less efficient allocation of resources. When barriers to entry limit the number of firms in the market, existing firms may be able to charge higher prices and produce less than the socially optimal quantity, resulting in a deadweight loss to society. Barriers to entry can thus reduce the efficiency of a perfectly competitive market by allowing firms to exercise some degree of market power.
• Analyze how barriers to entry contribute to the formation of a monopoly and influence a monopolist's pricing and output decisions.
  • Barriers to entry are a key factor in the formation and persistence of monopolies. When significant barriers to entry exist, such as control over a scarce resource, economies of scale, or government regulations, it becomes difficult for new firms to enter the market and challenge the incumbent monopolist. This allows the monopolist to maintain its position and charge higher prices and produce less than the socially optimal quantity, resulting in a deadweight loss to society. The monopolist's pricing and output decisions are directly influenced by the presence of barriers to entry, as they enable the firm to exercise its market power and maximize profits without the threat of new competition.

Related terms

Monopoly:

A market structure where a single firm is the sole producer of a good or service, often due to high barriers to entry that prevent competition.

Economies of Scale:

The cost advantages that businesses can exploit by expanding their scale of production, which can create a barrier to entry for smaller firms.

Sunk Costs:

The upfront, non-recoverable costs that a firm must incur to enter a market, such as investments in infrastructure or research and development.