Contestability Flashcards
What is contestability in microeconomics?
How open a market is to competition at a given period of time.
What are the characteristics of a contestable market (2)?
1) Freedom of entry and exit.
2) Low exit costs.
What are the 5 assumptions behind the concept of contestability?
1) No barriers to entry or exit. There are low sunk costs.
2) Firms are profit maximisers, producing at MC = MR.
3) The number of firms within a contestable market can vary from one to many.
4) No collusion between firms.
5) Perfect knowledge exists in the market, with firms having access to the same technology.
What are sunk costs?
Costs that, once have been incurred, cannot be recovered. E.g. advertising costs, highly specialist equipment, rent.
What is the effect of the existence of sunk costs on contestability within markets?
The existence of sunk costs reduce contestability within markets, as some firms may be deterred from entering the market.
What is ‘hit and run’ competition?
A strategy used by some firms to enter a market, undercut competitors, and then leave once they have achieved the lack of barriers of entry/exit.
What is an example of a barrier to entry?
The need for advertising/branding, high entry and exit costs, high sunk costs, etc.
Why do firms in a contestable market act in a similar way to firms in a perfectly competitive market?
Because of the threat of rivals entering the market.
What are 2 factors influencing the degree of contestability in a market?
The lower the barriers of entry/exit, the higher the degree of contestability. Technology is also improving contestability across markets.
