3.4.7 Contestable Markets

Question 1

What is a contestable market?

Answer 1

Is one where there is a threat of competition

Question 2

What characteristics need to exist for there to be a contestable market?

Answer 2

• low barriers to entry/exit
• large pool of potential entrants
• good information
• incumbent firms must be subject to hit and run competition

Question 3

How has technology increased contestability?

Answer 3

• lower barriers to entry
• increase the pool of entrants to the market
• improved information

Question 4

What are the outcomes of a contestable market?

Answer 4

Use a monopoly market as an example. Before, firms operate at the profit maximising point (where MR = MC and MC is rising), but change and operate at AC = AR. It makes no sense for a monopoly to operate at profit max point as it will attract entrants

Question 5

In a contestable market, why would a firm want to operate at AC = AR?

Answer 5

This is the break even point, normal profit point and called the limit price

Question 6

In a contestable market, why would a firm (especially a monopoly firm) want to eliminate the threat of competition?

Answer 6

To take away for incentive for firms to take the supernormal profit and enter the market

Question 7

What are the pros of a contestable market?

Answer 7

• become more allocatively efficient
• productive efficiency
• X efficiency

Question 8

What are the cons of a contestable market?

Answer 8

• lack of dynamic efficiency

- cost cutting in dangerous areas