4.1.5.9 Contestable and non-contestable markets Flashcards
What are the key characteristics of contestable markets?
Free entry/exit
Access to technology
No sunk costs
Low consumer loyalty
Threat of ‘hit-and-run’ competition
What is hit-and-run competition?
When firms quickly enter to capture supernormal profits then exit, keeping existing firms competitive.
How do contestable markets affect firm behavior?
Firms act competitively (like perfect competition) due to threat of entry, leading to:
- Productive efficiency
- Allocative efficiency
- Normal profits long-run
What are sunk costs?
Unrecoverable expenses (e.g., advertising) that reduce market contestability by increasing entry risk.
What types of barriers reduce contestability?
Entry Barriers:
- Economies of scale
- Legal protections (patents)
- Brand loyalty
- Predatory pricing
Exit Barriers:
- Asset write-offs
- Contractual obligations
- Redundancy costs
How does predatory pricing work?
Incumbents set prices below cost to drive out rivals → reduces competition → raises prices later.
What is limit pricing?
Setting prices low enough to deter new entrants while maintaining profits.
How do vertical integration and brand proliferation reduce contestability?
Vertical integration: Controls supply chains/tech
Brand proliferation: Masks market concentration
Why are contestable markets efficient?
Threat of entry forces firms to:
- Minimize costs (productive efficiency)
- Set P=MC (allocative efficiency)
- Innovate (dynamic efficiency)
What are real-world examples of contestability?
Budget airlines (plane leasing)
Bus routes (government-regulated entry)
Digital markets (low sunk costs)
How do sunk costs affect market structure?
High sunk costs → Less contestability → More monopoly-like outcomes.
Why might contestable markets have few firms?
Threat of potential competition (not actual competitors) keeps firms behaving competitively.
What’s the relationship to perfect competition?
Contestable markets achieve similar efficiency outcomes without requiring many firms.
How does consumer loyalty affect contestability?
Strong brand loyalty → Inelastic demand → Harder for new entrants → Less contestable.
What are anti-competitive practices?
Tactics like:
- Exclusive supplier contracts
- Tech hoarding
- Refusing to deal with competitors’ retailers
Why are no markets perfectly contestable?
All real markets have some entry/exit costs and consumer loyalty factors.
How did Amazon reduce contestability?
Through:
- Kindle exclusivity
- Short-term losses to gain dominance
- Exploiting scale economies
What’s the role of government in contestability?
Can increase contestability by:
- Reducing entry barriers
- Preventing anti-competitive practices
- Subsidizing new entrants
Why are legal barriers effective?
Patents/licenses legally block competition (e.g., taxi medallions, drug patents).
How do exit barriers affect contestability?
High exit costs (e.g., layoffs, leases) deter initial entry → Less contestable.
