3.4.7 - Contestability Flashcards
How can a firm prevent the entry of other firms ?
They can charge such a low price that it would be unable to reap any supernormal profits at all
- Therefore deterring others to enter the market
What does a market have to be for it to be contestable ?
It must have no barriers to entry or exit and no sunk costs.
What are sunk costs ?
They refer to costs a firm incurs in setting up a business and which cannot be recovered if the firm exits the market
What could happen if a firm sets a price higher than the average costs ?
As §soon as it does this, it will open up the possibility of a hit and run entry by new firms
They can enter and compete away the supernormal profit
How can a firm avoid new firms committing a hit and run entry ?
By setting the price equal to the average cost
So there are no supernormal profits to act as an incentive for entry
What is a moot point ?
A moot point is whether the threat of entry will in fact persuade firms that they cannot set a price above average cost
What are some examples of sunk costs ?
Advertising
How has the growth of the internet had an effect on contestability ?
By making information more freely available, the internet has given consumers improved knowledge of market conditions and enabled them to make more informed choices.
Furthermore, the growth of online sales has made it much easier for new firms to enter markets.
Give an example of a deterrence strategy to a firm that is being used
Higher fixed costs to enter and be in the market
How can the amount of money a firm spends on advertising affect other firms ?
If the firms in an industry typically spend heavily on advertising, it will be more difficult for new firms to become established, as they too will need to advertise widely in order to attract customers.
What can a well known brand image achieve for a firm ?
It will ensure customer loyalty.
What kind of cost is R&D ?
This is another component of fixed costs, as it does not vary with the volume of production.
How does R&D act as deterrence for new firms ?
They will need to invest heavily in R&D if they are going to keep up with the new and better products that are always coming on to the market.
What is the key assumption to contestability ?
The key assumption for contestability is that
businesses are free to enter and leave the market.
