3.4.7 Contestability Flashcards
Contestable market
• must have no barriers to entry or exit
• have no sunk costs – a firm’s start-up costs that they cannot recover if they exit the market
• new firms must have no competitive disadvantage compared to the incumbent
• must have access to the same technology.
Incumbents
- they cannot set a price above AC - if they do and earn supernormal profits others will enter and compete the profits away
What happens if businesses make supernormal profits?
• this would make them vulnerable to a ‘hit and run’ entry by a new firm
• they would come into the market, take some profits and then exit again.
How might incumbent firms prevent new firms from entering?
- the incumbent firm may charge where P=AC where there are no supernormal profits and no incentive for entry to the market.
- Alternatively the incumbent firm(s) may charge a limit price, i.e. one below the profit maximising price and low enough to deter new entrants.
Barriers to entry
obstacles that limit a firm’s ability to enter, set up or extend into new markets.
Barriers to exit
factors that prevent firms leaving a market or, when a firm is making a loss, make it more unprofitable to leave.
- Examples of this include sunk costs – costs that are irretrievable – such as advertising.
Examples of barriers to entry
• illegal anti-competitive practices by incumbents, including predatory and limit pricing
• the nature of the business causing barriers to exist, such as economies of scale
• legally imposed barriers –patents, state-owned franchises such as train operating companies and legislation that allows firms to operate such as postal services and 4G licenses.
Sunk costs
costs that are irretrievable
- e.g advertising costs.
- high sunk costs = make entry to and exist from that market less attractive and therefore make the market less contestable.
Assumptions of contestable markets
- No single firm has a significant share of the market
- Freedom of entry and exist
- Firms compete and do not collude to fix prices
- Firms are short run profit maximisers
- There’s perfect knowledge in the industry
Impact of nationalisation of rail industry on employees
- won’t protect employees due to maximum wage
How can nationalisation protect other workers by preventing the abuse of power?
- executives likely to managerial objective and there might be x inefficiency
- prevent managers from seeking profit for their own personal gain but rather for the benefit for other workers and consumers.
Impact of nationalisation on efficiency evaluation
- in reality, railway might not increase inefficiency
- current train strikes is evident that the system isn’t working and govt isn’t willing to increase wages or provide funds
- govt is willingly to underpay state teachers and nhs workers therefore are willing to extract surplus (current public sector workers struggle over pay rise)
- therefore it’s unlikely train can do better under state control
Impact of nationalisation on efficiency evaluation
Their short term priority is winning votes and election, without looking at long run goals. Private and govt sector can under invest and under pay.
Why are some arguments for maximum wage?
- people earn too much
- Prevents the most skilled labour migrating to the highest paid jobs.
Example of maximum wage
- Southern rail
- professional footballers in England up until 1960
Should Football League have maximum wage?
- With many clubs on the face of bankruptcy, some argue, the Football League should consider a return to a maximum wage = prevent clubs spending more than they can afford on wages.
- However, this is the nature of football clubs – where clubs have a tendency to push themselves towards the brink of bankruptcy.
What are some arguments against having maximum wage?
- cold just increase income tax = govt benefit
- disincentives to work (skilled workers might move to lower skills jobs with higher pay)- economy is not being used to full capacity
- high wages often = high value workers/high skill
Why might food delivery services be seen as elastic?
- luxury good = not a necessity
Why might food delivery services be seen as inelastic?
- as society develops, ppl become lazier = deliveries more attractive due to availability & convenience
- UK lockdown = restaurant closed
- so price paid seems adequate
- high barriers to entry (dominated by small no. Firms) = oligopoly = small firms hard to compete with lower delivery fees = firms often compete with non price factors = lack of substitutes
Policies to increase contestability in markets
- market liberalisation
- tougher competition policy
- new technology
How has market liberalisation increased contestability?
E.g broadband services & parcel deliveries have both been liberalised over the years = has led to a substantial increase in the intensity of price and non-price competition
How has tougher competition policy improved contestability?
- the UK competition & markets authority (CMA) & the EU competition commission have been proactive in investigating allegations of anti-competing practices
Example of competition policy
- The CMA stopped the merge between Sainsbury’s and Asda = would lead to a substantial lessening of competition in the retail grocery sector.
- That said, only 12 mergers and takeovers have actually been prohibited / blocked in the UK between the years 2004 and 2018
Are barriers to entry coming down?
- rise of lean start-ups (breaking into markets with minimum viable products)
- viral marketing via social media can cut the costs of attracting new sales
Advantages of low entry barriers
- market becomes more contestable in the long run
- in theory, more competition = lower prices/improve quality/higher productivity
Drawbacks from low barriers to entry
in practice:
* lower snp = less R&D
* lower profits = less tax revenue
* rapid entry of new firms = over supply = drags price lower = make industry less sustainable (renewable energy)
* risk of structural unemployment (e.g tech innovation)
* doesn’t guarantee of a contestable market (old monopoly replaced by new ones e.g Uber)
Maximum wage effectiveness
Tax more effective
Example of contestable market
low-cost airlines, internet service providers, electricity and gas suppliers,
Example of competitive market
Changing technology
(Mobile phones, medicine)
What is a contestable market?
- There is a threat of new market entries
