Contestability Flashcards
What is a contestable market?
A contestable market is a type of market structure that is competitive because of lack of barriers to entry.
Freedom to entry and exist.
No sunk costs.
Perfect knowledge.
Price can not be set above average cost as supernormal profits will attract hit and run competition to enter the market.
Why do contestable markets differ from those in perfect competition?
A contestable market sells both homogenous or heterogeneous products.
Display elements of monopoly power (i.e. by being a price leader in a markets).
Be small in number (e.g. the market might be oligopolistic).
The significance of contestable markets is that firms can easily enter or exit the market to access to supernormal profits. This threat of potential entrants means that incumbent firms only make normal profits.
What some characteristic of contestable markets?
Freedom to enter or exit the market means that factors of production are perfectly mobile so no barriers to entry or exit.
The average costs of all firms are likely to be the same for both new entrants and existing firms as firms are unable to exploit economies of scale.
Modern technologies and new technologies can become outdated, so there is a reduction in barriers to entry as technology progressives.
The degree of contestability depends of the level of sunk costs. If there are highs sunk costs, there is lower contestability.
Perfect knowledge. When producers and consumers in a market are fully aware of the price, quantity available an other relevant information for all products when making buying and production decisions. This means that all firms have access to the same tech and can use it at the same cost. If a firms has a competitive advantage due to better tech this will lower average costs and impede entry into market for new firms, so market is less likely to be contestable.
