4.5 Contestable Markets

Question 1

What are the characteristics of contestable markets

Answer 1

Face actual and potential competition

Entrants have free access to production techniques and technology

No significant barriers to entry and exit

Low consumer loyalty

Question 2

What are the implications of contestable markets for the behaviour of firms

Answer 2

Firms are more likely to be allocatively efficient. In the long run firms operate at the bottom of the AC curve making them productively efficient

Threat of new competitors effects firms just as much as existing competitors due to low barriers to entry providing easy access

Supernormal profits in short run but only normal profits long run

Question 3

What is meant by legal barriers to entry and exit

Answer 3

Patents and exclusive rights to production meant other firms cannot enter the market

Question 4

What is meant by predatory pricing

Answer 4

This involves setting low prices to drive out firms already in the industry

Question 5

What is meant by limit pricing

Answer 5

This discourages entry of other firms. Ensures price of a good is below that which a new firm entering the market would be able to sustain

Question 6

What is meant by vertical integration

Answer 6

This means one firm gains control of more of the market

Question 7

What is meant by brand proliferation

Answer 7

This disguises consumers from the actual market concentration

Question 8

What is meant by sunk costs

Answer 8

They are costs which cannot be recovered once they have been spent

Question 9

Advantages of a contestable market

Answer 9

May lead to lower prices for consumers owing to higher levels of competition

Higher levels of competition may reduce need for government intervention

Question 10

Disadvantages of contestable markets

Answer 10

Less likely to benefit from dynamic efficiency as firms will not earn supernormal profits