There are several barriers that can prevent firms from entering or leaving markets. Barriers to entry include economies of scale, brand loyalty, control of important technologies, expertise and reputation. Strategic entry deterrence by existing firms includes hostile takeovers, product differentiation, capacity expansions, and predatory pricing. Patents provide monopoly power but can also stifle competition. Innovation is both a barrier, through property rights, and an enabler, by reducing barriers. Process innovation lowers costs. Established firms have cost advantages from learning, integration, customer retention, and monopsony power. Legal barriers include licenses, patents, franchises, and import controls.

1. What barriers exist to firms entering and
leaving markets?
Topic 3.3.7

2. What barriers exist to firms entering and
leaving markets?
Topic 3.3.7
Students should be able to:
• Understand the meaning and types of barriers to entry
and exit and how they affect the behaviour of firms.
• Discuss the significance of barriers to entry and exit to
firms operating in different market structures.

3. Barriers to Entry in Monopoly
Economies of scale Vertical integration
Brand (consumer)
loyalty
Control of important
technologies
Expertise, goodwill
and reputation

4. Strategic Entry Deterrence
• Strategic entry deterrence involves any move by existing firms
to reinforce their position against other firms of potential
rivals.
• There are plenty of examples of this – including:
1. Hostile takeovers and acquisitions – taking a stake in a rival firm or
buying it up!
2. Product differentiation through brand proliferation (i.e. investment in
developing new products and spending on marketing and advertising
to reinforce consumer / brand loyalty).
3. Capacity expansions to achieve lower unit costs from exploiting
internal economies of scale.
4. Predatory pricing: Predatory behaviour happens when a dominant
company sustains losses in the short run in the knowledge it can
recoup them once the competition is forced to exit

5. Benefits of Patents for Businesses
• Helps to develop a competitive advantage via a unique
feature
• Provides a source of monopoly power
• Barriers to entry maintain supernormal profits in the
long run
• Enables firms to develop into a new market e.g. through
a disruptive technology that has been patented

6. Benefits of Patents for the Economy
1. Encourages Research and Development
2. Encourages exploitation of external economies of scale
e.g. research projects with universities
3. Innovation is encouraged e.g. gains in dynamic
efficiency that then reduce costs for consumers
4. Macro benefits, e.g. multiplier effects, gains in export
competitiveness, a source of economic growth
5. Investment in research in turn in the long run may
benefit society as a whole e.g. external benefits from
health research, environmental patented technology

7. Economic Disadvantages of Patents
1. Patents allow supernormal profits to be made – a
transfer of wealth to highly profitable monopolists
2. Patents may stifle competition or innovation by others
3. Disadvantages of monopoly e.g. loss of allocative
efficiency as prices charged are well above MC
4. May cause x-inefficiency due to the lack of
contestability in the market

8. Sustaining and Disruptive Innovations
1. Many new products are similar to existing ones – these
are known as “sustaining innovations”
2. “Disruptive innovations” upset the status quo. Joseph
Schumpeter from the Austrian school of Economics
said that innovation creates “gales of creative
destruction”
• Examples of disruptive innovations:
– Online streaming services, such as Spotify and Netflix
– The Uber app is a challenge to the power of established taxi
companies including London Black Cabs
– Air BNB is challenging dominant hotel chains in many cities
around the world

9. Innovation as a Barrier to Entry
1. Innovation can be a barrier to entry in markets -
property rights embedded in product innovations
might be protected by patent laws
2. There can be a “first mover advantage” for successful
innovators that gives them scope to exploit some
monopoly power in a market.
3. But high rates of innovation reduce barriers to entry
– Technology may free businesses from a single source of
supply – e.g. free Open Source software
– Technology is not always a source of competitive advantage
if competitors exploit it too

10. Process Innovation
1. Process innovations involve changes to how production
takes place, be it on the factory floor, business logistics
or methods of managing employees in the workplace.
2. The effects of process innovation can be both on a firm’s
cost structure (i.e. the ratio of fixed to variable costs) as
well as the balance of factor inputs used in production
(i.e. labour and capital)
3. Cost reducing innovations cause an outward shift in
market supply and they provide the scope for businesses
to enjoy higher profit margins with a given level of
demand. Process innovation should also lead to a more
efficient use of resources.

11. Most U.S. patents granted as of 2014
7,534
4,952
4,055
3,224
2,829
2,608
2,590
2,566
2,122
2,095
2,003
1,860
1,820
1,662
1,634
0 1000 2000 3000 4000 5000 6000 7000 8000
International Business Machines Corp
Samsung Electronics Co Ltd
Canon KK
Sony Corp
Microsoft Corp
Toshiba Corp
Qualcomm Inc
Google Inc
LG Electronics Inc
Panasonic Corp
Apple Inc
General Electric Co
Fujitsu Ltd
Seiko Epson Corp
Ricoh Co Ltd
Number of granted U.S. patents

12. 20 firms with highest R&D spend (2014)
13.5
13.4
10.6
10.4
10
9.9
9.1
8.2
8
7.5
7.2
7
6.7
6.6
6.4
0 2 4 6 8 10 12 14 16
Volkswagen
Samsung
Intel
Microsoft
Roche Holding
Novartis
Toyota
Johnson & Johnson
Google
Merck & Co.
General Motors
Daimler
Pfizer
Amazon
Ford
Expenditure (in billion U.S. dollars)

13. Cost Advantages for Established Businesses
Cost &
Price
Output (Q)
Cost advantage for Firm A
over a potential rival Firm B
At output Q1 – firm A has
a big cost advantage over
a potential rival firm B
Reasons?
Firm B
Firm A
Q1
AC (B)
AC (A)

14. Cost Advantages for Established Businesses
Cost &
Price
Output (Q)
Cost advantage for Firm A
over a potential rival Firm B
At output Q1 – firm A has
a big cost advantage over
a potential rival firm B
1. Learning economies
2. Vertical integration
3. Lower customer churn
4. Monopsony power
Firm B
Firm A
Q1
AC (B)
AC (A)

15. Entry Barriers – Unit Costs & Contestability
Cost & Price
Output (Q)
Low MES, limited scale
economies, contestable market
LRAC
Q1 Output (Q)
High MES, falling LRAC, barriers to
contestability
Extensive internal
economies of scale
leading to lower LRAC
LRAC
Natural Monopoly
Minimum
efficient
scale (MES)
Scope for many firms to
reach the MES
Q1 Q2 Q3 Q4

16. Global Brands

17. Global Brands

18. Apple over 10 Years

19. Strategies to Limit Effective Competition
Limit pricing tactics Predatory pricing tactics
Brand proliferation
When a firm sets price
low enough to
discourage new
entrants into the
market
Setting an artificially
low price for a product
in order to drive out
competitors

20. Legal (Statutory) Entry Barriers
Market licences Patent protection
State awarded franchises Import controls

21. What barriers exist to firms entering and
leaving markets?
Topic 3.3.7