3.9 Contestable and non contestable markets Flashcards
What is a contestable market?
A market in which the potential exists for new firms to enter the market. A perfectly contestable market has no entry or exit barriers and no sunk costs.
What is a non contestable market?
There is little / no potential for new firms to enter the market. There is high barriers to entry and exist and sunk costs are present.
What is hit and run competition?
New entrant can enter the market, make profit, then leave very easily.
In a contestable market why can’t price be set above average costs?
Price cannot be set above average cost as supernormal profits will attract hit and run competition to enter the market
Why are contestable markets different from perfect competition?
- Sell both homogenous (identical) or heterogeneous (different) products
- Display elements of monopoly power e.g. by being a price leader in the market
- Be small in number e.g. the market might be oligopolistic
What is an incumbent firm?
Firm that is established within a market
What does the threat of new entrants mean for incumbent firms?
The threat of potential entrants means that incumbent firms only make normal profits
What is the significance of contestable markets?
The significance of contestable markets is that firms can easily enter or exit the market to access supernormal profits
Explain how sunk costs impact the contestability of a market
If there are sunk costs, this discourages hit and run competition from entering a market. No sunk costs = a contestable market.
Explain how barriers to entry can impact the contestability of a market.
Barriers to entry make it more difficult / impossible for hit and run competition. No barriers to entry = a contestable market.
Explain how perfect knowledge can impact the contestability of a market.
Firms will know when there is abnormal profit in a market and may decide to enter as a result.
How does contestability impact on productive efficiency in a market?
Firms operate at the lowest point on their average cost curve. If they didn’t new firms would enter the market with lower AC and could charge a lower price
How does contestability impact on allocative efficiency in a market?
Occurs as firms:
only make normal profits (AR or P = AC)
operate at the lowest cost output (MC = AC)
Thus, P = MC the criterion for allocative efficiency
How does contestability impact on dynamic efficiency in a market?
Firms innovate production processes in order to lower AC. This is made easier as firms have greater access to industry wide technology.
