Contestability

Question 1

What is a contestable market

Answer 1

A contestable market refers to a market which is open to the threat of competition due to low barriers of entry and exit and no sunk costs which makes the market appealing to enter

Question 2

What are the characteristics of a contestable market

Answer 2

• low barriers to entry and exit
• low sunk costs
• new firms have no comeptive disadvantages to incumbent firms
• low brand loyalty - consumers must be willing to switch

Question 3

How does contestability affect the an incumbent firms behaviours

Answer 3

• due to a highly contestable market, incumbent firms are exposed and vulnerable to hit and run entry by firms who will take away some sumpernormal profits and leave the market
• to avoid this firms will set a price where p=ac and only normal profits are being made to take away the incentive of hit and run entry

Question 4

What is a moot point

Answer 4

• would the threat of competition fully persuade firms to not make supernormal profits
  They may just rather make smaller profits and respond aggressively when the threat does come

Question 5

How has the development of the internet increased contest-ability

Answer 5

• gives consumers improved knowledge of market conditions allowing them to make informed choices which makes more competitive
• easier for firms to enter the marke5 as they no longer have to open up physical shops they can make an online shop

Question 6

What are some other detterance strategies

Answer 6

• price is not the only factor which firms use to deter new entry, they also increase the cost of being in the market through fixed costs
  This can be done through increase in advertisement.
  Also can be done through research and development

Question 7

Why would increased advertisement deter new enTrants

Answer 7

• if firms heavily spend on advertising and their brand image, it would make it harder for firms to establish themselves as they would have to spend a lot on advertising .
• spending on advertisement and bran image also increases customer loyalty of firms. E.g sunny D

Question 8

How many firms be affected by increased contest ability (chain of reasoning) (question)

Answer 8

• a contestable market is a market which is open to the threat of competiona nd has the characteristics of Lowe barriers to entry and exit to a industry and no sunk costs.
• in a market where there is a lack of competition, in an unregulated market firms are Abel to profit maximise and Set price at a profit maximising equilibrium and restrain output
• however increased contestability would put competing pressure on firms to cut down on their prices as they are vulnerable to hit and run entry
• due to this firms would set price to average costs which would mean the market is only making normal profits to take away the incentive of new entry

Question 9

What are some benefits of contestable amrkwts

Answer 9

• increased competitive pressures will keep prices low and push firms closer to more efficient outcomes
• less need for gov.element intervention and regulation by cma

Question 10

Disadvantages of a contestable market

Answer 10

• a disadvantage if a contestable market is that it would make firms only achieve normal profits and not supernormal profits which would not allow firms to be dynamically efficient

Question 11

How else can firms decrease contestability

Answer 11

• increase barriers to entry such as;