3.4.7 Contestability

Question 1

Conditions for a market to be contestable?

Answer 1

• No barriers to entry or exit
• No sunk costs
• New firms not at competitive disadvantage (access to same technology)

Question 2

Contestable market definition?

Answer 2

Entrant has access to all production techniques available to incumbents, and no sunk costs

Question 3

Sunk costs definition?

Answer 3

Costs that a firm incurs in setting up a business which cannot be recovered if firm chooses to exit the market

Question 4

What happens when an incumbent firm sets a price higher than AC in a contestable market?

Answer 4

Opens up possibility of hit-and-run entry by new firms = they enter the market and compete away supernormal profits

Question 5

How has the internet impacted the contestability of markets?

Answer 5

• Consumers have increased knowledge of market conditions = more informed choices
• Growth of online sales = easier for new firms to enter markets

e.g. travel industry

Question 6

Deterrence strategies?

Answer 6

• Pricing
• Advertising and publicity
• Research and development