What is the impact of entry and exit barriers in the real world? In the perfectly competitive market model, there are no entry or exit barriers. Buyers can enter or exit any market at any time instantly. And that is an important secondary assumption underlying the assumption of no entry/exit barriers: no time lags between entry and exit. Under such assumptions, no single buyer or seller can dominate the market. More importantly, the possibility of extra-ordinary profits simply does not exist. If such profits are being made, new sellers will enter and drive prices down. If profits are too low, some existing buyers will exit. In all cases, the market will swiftly return to a hypothetical equilibrium point.
While economists are pontificating about such issues and teaching millions of innocent souls such theories, in the real world conditions are very different. Both entry and exit barriers exist. Also, things do not happen instantly. There is often a time lag which can be significantly long.
Entry barriers arise from many causes. They can be regulatory, financial or caused by the market size of the incumbents. A good example of regulatory entry barriers are the rating agencies in the US. The regulatory authorities demand that public companies get their bonds and stocks rated by a limited number of firms and by no other. Some markets are natural monopolies. In such cases, the nature of the market itself acts as an entry barrier. Most markets, specially digital ones, tend to have a winner take most nature. Such markets have two or three dominant firms and a bunch of niche players. The dominant firms act as strong entry barriers. Predatory practices also act as entry barriers although these tend to be discouraged by governments. Microsoft, as an example, cemented its near monopoly in the computer operating system market by penalizing hardware manufacturers who wanted to use other non-Microsoft operating systems. Copyrights and patents also serve as very strong entry barriers. These are like toll booths on a highway. Without the appropriate payment, no one else can enter. And the toll booth operator can shut down access to the highway completely. Copyrights and patents can be so lucrative that an increasing number of companies are becoming dependent on them for their revenue; a classic rent seeking action.
What about exit barriers? There are often cases of zombie companies which cannot survive on their own but which also refuse to die. Like zombies, they shuffle along consuming resources that could be put to better use elsewhere. Exit barriers often arise because of market failures. The company is unable to dispose of its assets and thus carries on its miserable existence.
What is the effect of entry and exit barriers on the economy? Does it matter if these exist? I believe that it matters hugely. These barriers distort market signals and result in a mis-allocation of resources. One of the strengths of the market system is supposed to be its ability to efficiently allocate resources through pricing signals. These kind of barriers prevent such allocation. A much more insidious effect of the entry and exit barriers is that these can inhibit innovation. The modern global economy depends on continuous innovation as a major engine of growth. These barriers inhibit this innovation. They tend to encourage the continuation of the status quo even beyond its usefulness. New ways, new product, new services tend to be undervalued and at best delayed and at worst never get to see the light of day. In the end, a few people prosper while the many suffer.
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