contestability

Question 1

Characteristics of contestable markets

Answer 1

-Low barriers to entry/exit - high startup costs, regulations

-Perfect information - firms can make informed decisions abt entering/ exiting/ adjusting production levels

-No sunk costs - will not suffer substantial financial losses

-No collusion - if firms try to raise prices or restrict output new competitors can quickly undercut them

Question 2

Implications of contestable markets

Answer 2

-Price competition since firms know new entrants can easily undercut prices

-Efficiency and innovation - incentive to operate efficiently to maintain competitive edge - threat of new entrants

-Short-term focus - sr focus on maximising profits as market conditions change rapidly
-Normal profits prevent competition

-No monopoly power

Question 2

Types of barrier to entry and exit

Answer 2

-Economies of scale - deter entrants as they can’t produce at such low average costs

-Capital requirement - high startup and capital investment costs

-Gov regulation

-Patents

-Level of advertisement and brand loyalty

Question 3

Sunk costs and the degree of contestability

Answer 3

-Low sunk costs - easier to exit the market if conditions become unprofitable

-High sunk costs like investments or infrastructure - firms continue to operate in absence of profits

Question 4

benefits of contestable markets

Answer 4

-Allocative efficiency - low prices
-X-efficiency - incentives for firms to cut costs
-Firms respond to consumer preferences