contestability (L14)

Question 1

factors needed for a market to be contestable

Answer 1

no barriers to entry/exit
no sunk costs
new firms must have no competitive disadvantage compared with incumbent firms
access to same tech

Question 2

sunk costs

Answer 2

costs a firm incurs in setting up a business and can’t be recovered if the firm exits the market

Question 3

incumbent market

Answer 3

leader in the industry

Question 4

why can’t the incumbent firm set a price that’s higher than average cost?

Answer 4

it opens up the possibility of hit and run entry by new firms

Question 5

hit and run entry

Answer 5

firms entering the market, taking some of the supernormal profits, then exit again, so without supernormal profit there is no incentive for entry

Question 6

how has the internet affected contestability

Answer 6

consumers have better knowledge of market conditions so make more informed choices
growth of online sales makes it easier for new firms to enter the market

Question 7

example of contestability on the internet

Answer 7

travel industry
2012 UK residents made 56 mill+ trips abroad arranged by high street travel agents, online firms started competing effectively with established firms so consumers could make travel arrangements easier.

Question 8

entry deterrence strategies

Answer 8

limit pricing
raising fixed costs of being in the industry
(advertising&publicity, research &development)

Question 9

advertising & publicity

Answer 9

this is fixed as expenditure on it doesn’t vary with output, if firms spend more on it then it’s harder for new firms to be established, same with spending on well known brand image to ensure customer loyalty
costs of excessive advertising can be a social cost for monopolies if it fails

Question 10

research & development

Answer 10

some industries spend a lot on research eg pharmaceutical industry that spends a lot on researching new drugs