3.4.7: Contestability Flashcards
What is a contestable market?
A market with a high threat of competition, keeping firms producing at a competitive level.
What are the characteristics of a contestable market?
-Low barriers of entry & exit in the market (no sunk costs, subject to hit & run competition).
-Low costumer loyalty.
-Perfect knowledge (when one firm makes supernormal profit, other firms enter the market).
-Firms are short term profit maximisers and don’t collude.
What is hit & run competition?
Where firms enter and exit the market quickly, selling their product for a short period of time and then leaving.
What is a sunk cost?
An expense that can’t be recovered if a business leaves an industry.
What is an example of a sunk cost?
Advertising.
How do sunk costs affect degree of contestability?
The lower the sunk costs, the more contestable a market is (as there can be regular hit & run competition).
What is an example of contestability?
UK budget airline industry (RyanAir): renting planes at cheap prices and choosing less popular landing spots.
Why is a perfectly contestable market not realistic?
All firms will face sunk costs: even if assets are resold, it is generally for a lower price.
What is the implication of contestable markets on firm behaviour?
Other firms will enter the market if they see existing firms making supernormal profit, performing a hit & run. This takes away profit from existing firms, who may decide to do the following:
-Limit pricing: reduces the incentive for firms to enter the market.
-Productive efficient: producing at lowest AC.
-Allocative efficient: producing to tailor customer wants.
What may act as barriers to entry for a contestable market?
-Economies of scale: new firms operate at higher AC than large existing firms.
-Legal barriers: market licenses for the taxi industry.
-Marketing barriers: high levels of advertising to increase brand loyalty.
-Anti-competitive practices: refusing to buy from suppliers that stock competitors.
