contestability Flashcards
what is contestability based on?
based around potential threat of competition
what are the characteristics of contestability?
- absence of entry/exit barriers
- pool of potential entrants
- perfect information
- incumbents vulnerable to hit + run competition as they have no cost advantage over hut and run entrants
- no sunk costs
- exit/entry must be rapid
- normal profits are made
how does the absence of entry/exit barriers make a market more contestable?
- increases the threat of entry
- makes the market contestable
- firms are willing to compete
- firms attracted to supernormal profit in the market
what is an incumbent firm
firms that are already in the market
what is hit and run competition
hit + run competition is when new firms come in and they grab some of the supernormal profits being made in the short run and then leave the market
if a market is perfectly contestable how will an incumbent firm react?
- firms know its risky to make supernormal profit as it would incentivise new entry
- would think to reduce their supernormal profits
- firms would go to the point of normal profit where AR=AC
what is the entry limit price
firms would go to the point of normal profit where AR=AC
why does AC=AR in a contestable market
eliminate threat by dec profit margin
prepared if threat becomes real as prices are low and quantities are high
whats the difference between a competitive market and a contestable market?
competitive market- is about actual competition
contestable market is about potential threat
why may contestable markets be good?
- the more contestable the markets are, the more the outcomes are like competitive outcomes
- price dec, quantity inc
- allocative + productive efficiency
- if firms want to be competitive they have to be as efficient as possible to negate the threat
- inc in consumer surplus
- job creation
- x-efficiency
- competition policies such as liberalisation of a market can help to open up an industry to new suppliers or persuade consumers to switch in great numbers to help to increase contestability
how can you evaluate contestable markets?
- supernormal profits wont be made
- lack dynamic efficiency?
- if new firms come in with innovative ideas, that itself is the benefit of dynamic efficiency
- may not be a big decrease in prices
- cost cutting may be taken place in undesirable ways
- e.g cutting wages
- when new firms come in they may destroy existing firms
- may lead to job losses
- anti competitive strategies
how could you evaluate the point that contestability could lead to job losses?
if large new firms enter the new market, then where jobs have been destroyed, those workers can move to the new firms and still work in the same industry
what could anti competitive strategies lead to?
could lead to static inefficiencies
what do the effects of contestability depend on?
- length of contestability
- role of technology
- can improve info acquiring consumer data
- may lead to price discrimination
- regulation
- minimise cost cutting in dangerous areas
- protect product standards, health and safety etc
- dynamic efficiency
what are sunk costs and give examples
costs that a firm cant recover
e.g asset write-offs
closure of project cncellation costs
loss of business reputation and goodwill
