Effect of Entry and Exit Conditions on Competition

Maintaining above-normal profits or inefficient operations over the long run requires substantial barriers to entry, mobility, or exit. A barrier to entry is any factor or industry characteristic that creates an advantage for incumbents over new arrivals. Legal rights such as patents and local, state, or federal licenses can present formidable barriers to entry in pharmaceuticals, cable television, television and radio broadcasting, and other industries. A barrier to mobility is any factor or industry characteristic that creates an advantage for large leading firms over smaller nonleading rivals. Factors that sometimes create barriers to entry and/or mobility include substantial economies of scale, scope economies, large capital or skilled-labor requirements, and ties of customer loyalty created through advertising and other means.

It is worth keeping in mind that barriers to entry and mobility can sometimes result in compensating advantages for consumers. Even though patents can lead to monopoly profits for inventing firms, they also spur valuable new product and process development. Although efficient and innovative leading firms make life difficult for smaller rivals, they can have the favorable effect of lowering prices and increasing product quality. Therefore, a complete evaluation of the economic effects of entry barriers involves a consideration of both costs and benefits realized by suppliers and customers.

Whereas barriers to entry can impede competition by making entry or nonleading firm growth difficult, competitive forces can also be diminished through barriers to exit. A barrier to exit is any restriction on the ability of incumbents to redeploy assets from one industry or line of business to another. During the late 1980s, for example, several state governments initiated legal proceedings to impede plant closures by large employers in the steel, glass, automobile, and other industries. By imposing large fines or severance taxes or requiring substantial expenditures for worker retraining, they created significant barriers to exit.

By impeding the asset redeployment that is typical of any vigorous competitive environment, barriers to exit can dramatically increase both the costs and risks of doing business. Even though one can certainly sympathize with the difficult adjustments faced by both individuals and firms affected by plant closures, government actions that create barriers to exit can have the unintended effect of retarding industrial development and market competition.


A market with one buyer

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