5.9 Contestable And Non-Contestable Markets Flashcards
1
Q
What is meant by a contestable market?
Give examples
A
- one that’s easy to enter and exit, meaning new firms can quickly enter and compete with existing firms.
- e.g. retail industry, food trucks, freelance markets, coffee shops (all have low barriers to entry and exit)
2
Q
What are the characteristics of a contestable market?
A
- Contestable markets face actual and potential competition.
- Entrants to contestable markets have free access to production techniques and technology.
- There are no significant entry or exit barriers to the industry-for example, there will be no sunk costs in a contestable market.
- There is low consumer loyalty.
- The number of firms in the market varies.
3
Q
What are the implications of contestable markets for the behaviour of firms?
A
- If markets are contestable, firms are more likely to be allocatively efficient. p=mc
- In the long run, firms operate at the bottom of the average cost curve. This makes them productively efficient.
- The threat of new entrants affects firms just as much as existing competitors-Due to the low barriers to entry which provide easy access to the market, firms are wary of new entrants entering the market, taking supernormal profits, and then leaving.
-This is also called hit-and-run competition. - Markets which are highly contestable are akin to a perfectly competitive market because existing firms act as though there is a lot of competition.
- There could be supernormal profits in the short run and only normal profits in the long run.
- In the short run, new firms can enter and take advantage of the supernormal profits-however, in practice, firms can only earn normal profits in the short run.
-This is because it is the only way to prevent potential competition. - Without supernormal profits, there is no incentive for new firms to enter, even if barriers to entry and exit are low.
4
Q
What is the significance of barrier to entry?
A
- Barriers to entry are designed to prevent new firms from entering the market profitably.
- It increases producer surplus and reduces contestability.
5
Q
Types of barriers to entry and exit
*Economies of scale
A
- The greater the economies of scale that a firm exploits, the less likely it is that a new firm will enter the market.
- This is because they would produce comparatively expensively, so they cannot compete.
6
Q
Types of barriers to entry and exit
*legal barriers
EXAMPLE-TAXI INDUSTRY
A
- Legal barriers can act as a barrier to entry.
- For example, patents and exclusive rights to production (such as with television) mean other firms cannot enter the market.
- Some industries, such as the taxi industry, gain market licences to operate. Since
new firms have to gain a licence, there is a barrier to entry.
7
Q
Types of barriers to entry and exit
*predatory pricing
A
- involves firms setting low prices to drive out firms already in the industry.
- In the short run, it leads to them making losses.
-As firms leave, the remaining firms raise their prices slowly to regain their revenue. - They price their goods and services below their average costs.
- This reduces contestability.
8
Q
Types of barriers to entry and exit
*limit pricing
A
- involves the existing firm setting the price of their good below the production costs of new entrants, to make sure new firms cannot enter profitably.
9
Q
Barriers to entry and exit
*anti-competitive practices
A
- Some firms might employ anti-competitive practices, such as refusing to supply
retailers which stock competitors
10
Q
Barriers to entry and exit
*vertical integration
A
- means one firm gains control of more of the market, which creates a barrier to entry.
- It could result in one firm gaining control of important technologies, and they might prevent other firms gaining access to them.
11
Q
Types of barriers to entry and exit
*brand proliferation
A
- Firms might saturate the market with their goods using brand proliferation.
- This disguises consumers from the actual market concentration.
- For example, the many brands of the laundry soap market are provided by only a few large conglomerates.
12
Q
What are the consequences of barriers to entry and exit?
APPLICATION-Amazon
A
- they prevent firms from leaving a market quickly and cheaply.
- They include the cost to write off assets and pay leases-firms have to continue paying leases and contracts, even after closure.
-It could make it cheaper to stay in the industry than to leave which makes the market less contestable - Losing a brand and consumer loyalty is still considered a cost of leaving the market.
- The cost of making workers redundant might discourage firms from leaving an
industry.
-For example, Amazon created barriers to entry by exploiting their workers and
having exclusivity with the Kindle.
-They gained a large market share and a strong buying power.
-By lowering the price of the Kindle when it was launched, they made a loss in the short run, to increase their long run revenue.
13
Q
The degree of contestability
APPLICATION-Bus industry, budget airline industry (ryan air)
A
- There are different degrees of contestability across markets.
- All markets have the potential to be contestable, but it depends on what kind of costs firms face, and how loyal consumers are.
- An application point of contestability could be the bus industry, which the government helps to make more contestable.
- Also, the budget airline industry could be seen as having some degree of contestability, if firms rent planes for a few years and then sell them.
- Ryanair entered the market cheaply by choosing less popular landing slots. In recessions, however, the market is less profitable.
14
Q
What are sunk costs?
A
- Sunk costs are a barrier to contestability.
- They are costs which cannot be recovered one they have been spent.
- For example, advertising incurs a sunk cost
- A market with high sunk costs is less favourable to enter, because the risks associated with entering the market are high.
- High sunk costs are likely to push a market towards a price and output that is similar
to a monopoly.
