Contestability

Question 1

Contestable markets

Answer 1

A market where an entrant has access to all production techniques available to incumbents and entry decisions can be reverse without costs.

Question 2

What is used to indicate market structure?

Answer 2

-Number of firms in the market
-Product differentiation
-Concentration ratios of top firms
-Barriers to entry

Question 3

Key conditions of a contestable market

Answer 3

-A pool of new businesses who are willing and ready to enter the market
-No significant entry or exit costs (e.g. sunk costs)
-Equal access to available industry technologies
-Low rates of existing customer loyalty

Question 4

Contestable markets overview

Answer 4

-Almost all markets are contestable to a degree
-Can be seen at a local, regional or national level
-Contestable markets and the technology within them are always changing
-Shows high dynamic efficiency - challenger brands attacking established operations

Question 5

Pricing options in a contestable market

Answer 5

Profit max (MC=AR), revenue max (MR=0) or sales max(AC=AR)

Question 6

Profit maximisation in contestable markets

Answer 6

Abnormal profits acts as a magnet and the assumption of contestable markets means that new firms can enter and compete on the same basis as incumbent firms. This is knows as a hit and run and firms will only stop entering the market when normal profit is reached. This is a powerful disincentive for firms currently in the market earning abnormal profit.

Question 7

Revenue maximisation in contestable markets

Answer 7

This leads to a lower price and higher output. This means a lower profit margin is made - usually consumer welfare

Question 8

Sales maximisation in contestable markets

Answer 8

The firm is now earning normal profit and there is now no incentive for firms outside the market to enter the market

Question 9

Key points of a contestable market

Answer 9

-The threat of new competition is a powerful influence on the behaviour of existing established firms
-Resembles perfect competition as incumbent firms behave as if there were intense competition.
-There may be competition policies e.g. liberalisation of a market. May be effective in ensuring monopoly power isnt abused