3.4.7

Question 1

Characteristics of contestable markets

Answer 1

• contestable markets face actual and potential competition
• entrants to contestable markets have free access to production techniques and technology
• there are no significant entry or exit barriers to the industry
• there is low consumer loyalty
• the number of firms in the market varies

Question 2

Implications of contestable markets for the behaviour of firms

Answer 2

-if markets are contestable, firms are more likely to be allocatively efficient
In the long run, firms operate at the bottom of the average cost curve-this makes them productively efficient
- the threat of new entrants affects firms just as much as existing competitors
- markets which are highly contestable are akin to a perfectly competitive market
- there could be supernormal profits in the short run and only normal profits in the long run

Question 3

Types of barrier to entry and exit

Answer 3

• barriers to entry aim to block new entrants to the market, it increases producer surplus and reduces contest ability
• the greater the economies of scale that a firm exploits, the less likely it is that a new firm will enter the market
• legal barriers can act as a barrier to entry
• consumer loyalty and branding can make a market less contestable
• predatory pricing
• limit pricing
• some firms might employ anti-competitive practices
• vertical integration
• brand proliferation
• write off assets and pay leases
• losing a brand
• the cost of making workers redundant

Question 4

the degree of contestability

Answer 4

Different degrees of contest-ability across markets
It’s hard to judge the degree of contestability, since in reality there will be costs to entry and exit

Question 5

Sunk costs

Answer 5

Sunk costs are a barrier to contestability
They are costs which cannot be recovered once they have been spent
High sink costs are likely to push a market towards a price and output that is similar to a monopoly