Contestability

Question 1

What are the characteristics of a contestable market?

Answer 1

1. Low brand loyalty
2. Low barriers to entry and exit
3. Perfect information and accessibility to technology for producers

bonus

fear of hit and run - firm enter an industry to take advantage of temporarily high market profits

Question 2

List the types of barriers to entry

Answer 2

1. High sunk cost
2. High economies of scale
3. Legal barriers
4. Anti-competitive practices
5. Brand loyalty

Question 3

Define sunk cost

Answer 3

Cost that cannot be recovered

Question 4

Explain how economies of scale lead to high barriers of entry

Answer 4

High economies of scale mean a lowered ATC, leading to lower MC and AC cost

Firms can then lower their prices to prevent new competitors from entering the market as new firms cannot compete with existing firms on price.

Question 5

How does contestable market affect firms’ behaviour

Answer 5

Firms may fear hit-and-run or threat from existing firms;

This may cause them to
1. Price limit over profit maximise to prevent new firms entering
2. Sales maximise to get a foothold in the market
3. Focus on non-price competition to make their products more differentiated -> more pricing power