3.4.7 - Contestability

Question 1

What Is A Contestable Market?
(2 Points)

Answer 1

~ One where there is a threat of competition or entry.

~ Any attempt to make huge profit will mean other businesses will be attracted to the industry.

Question 2

What Are The Characteristics Of A Contestable Market?
(8 Points)

Answer 2

~ Low barriers to entry / exit.

~ Large pool of potential entrants.

~ Good information of market conditions.

~ Incumbent firms are subject to hit and run competition.

~ Relative absence of sunk costs.

~ Low product loyalty.

~ Best available technology.

~ Absence of sunk costs.

Question 3

What Is Hit & Run Competition?

Answer 3

New firms enter the market quickly and snatch the supernormal profits and leave the market quickly before incumbent firms react and decrease their profit margins.

Question 4

How Has Technology Increased Contestability?
(3 Points)

Answer 4

~ Decreased barriers to entry and exit, firms don’t have to be physical.

~ Increased the pool of potential entrants.

~ Increased information.

Question 5

How Has Technology Lead To Decreased Barriers To Entry & Exit?
(3 Points)

Answer 5

~ Decreased start up costs.

~ No need to hire workers.

~ EOS and advertising are easy to achieve.

Question 6

How Has Technology Lead To Increased Pool Of Potential Entrants?
(2 Points)

Answer 6

~ Technology has allowed greater innovation.

~ Allowed firms to find cheaper ways to do things.

Question 7

How Has Technology Lead To Increased Information?
(2 Points)

Answer 7

~ Easier access to information.

~ Better communication.

Question 8

What Are The Benefits Of Contestability?
(4 Points)

Answer 8

~ AE, as price decreases, increased choice and increased consumer surplus.

~ PE, greater exploitation of EOS, decreased costs and price.

~ XE, decreased costs and price, decreased waste.

~ Job creation, as labour is a derived demand.

Question 9

What Are The Drawbacks Of Contestability?
(4 Points)

Answer 9

~ Lack of DE, due to lower profit margins and no progress overtime.

~ Concerns about cost cutting taking place in the right area.

~ Creative destruction, new firms enter means more innovation destroys incumbent firms.

~ Anti-competitive strategies.

Question 10

How Can You Evaluate Contestability?
(4 Points)

Answer 10

~ Length of contestability, patents decrease contestability.

~ Role of technology.

~ Regulation.

~ DE.

Question 11

What Is A Barrier To Entry?
(2 Points)

Answer 11

~ Any obstacle that prevents a new firm entering a market.

~ Lloyds TSB.

Question 12

What Are All The Types Of Barriers To Entry?
(4 Points)

Answer 12

~ Legal.

~ Technical.

~ Strategic.

~ Brand loyalty.

Question 13

Describe The Legal Barriers To Entry
(5 Points)

Answer 13

~ Patents.

~ Licenses and permits.

~ Red tape.

~ Insurance.

~ Excessive standards and regulations.

Question 14

Describe The Technical Barriers To Entry
(4 Points)

Answer 14

~ High start up costs.

~ High sunk costs.

~ EOS, low cost scare of new firms.

~ Natural monopolies.

Question 15

Describe The Strategic Barriers To Entry
(3 Points)

Answer 15

~ Predatory prices.

~ Limit price, pricing at BE.

~ Heavy advertising.

Question 16

Describe The Brand Loyalty Barriers To Entry
(5 Points)

Answer 16

Consumers are loyal to different businesses when you enter a market.

Question 17

What Are Barriers To Exit?

Answer 17

Any obstacle that prevents a firm leaving a market.

Question 18

What Are The 4 Barriers To Exit?
(4 Points)

Answer 18

~ Under valuation of assets.

~ High redundancy costs.

~ Penalties for leaving contracts early.

~ Sunk costs.