Contestabillity (3.4.7) Flashcards
What is a contestable market?
Occurs when there is freedom of entry into a market and where costs of exit, sunk costs are low
How are contestable market and competition different?
Contestable market- based upon threat of new entrants
Contestable competition- based upon number of firms competing in a market
What are the characteristics of contestable markets?
- No barriers to entry or exit- Allows firms to easily leave or join the market.
2.No competitive disadvantages on entry- new firms can set up immediately and have access to the same technology.
3.Perfect information- no proprietary knowledge that would limit competition.
4.Hit- and - run competition- new firms can easily enter the market, extract profit then leave
What are barriers to entry?
Conditions that make it difficult or expensive for a firm to enter a market in order to compete with the existing suppliers
What are barriers to exit?
Factors that either prevent a firm from leaving the market or make it difficult to leave even if they are making a loss
What are some types of barriers to entry?
- E of S cause lower cost per unit and lower prices so hard for new firms to compete
-Legal barriers such as patents, copyright and govt licenses
-Ownership of essential resources can limit new entrants
-Anti-competitive practices like predatory pricing, limit pricing and aggressive takeover to limit amount of competition
What is one of the main barriers to exit?
Sunk costs
What are sunk costs?
An investment that has been made that cannot be recovered. If sunk costs in an industry are high it will limit competition and decrease contestability as firms will be more hesistant to enter.
What’s an example of sunk costs?
Companies often spend large sums on developing new products or technologies. For example, a pharmaceutical company that spends millions researching a new drug that ultimately fails in clinical trials has incurred a sunk cost. The money spent on research cannot be recovered, even though it was essential to the process of innovation.
If the sunk costs are high is the market more or less contestable?
Less contestable
If the sunk costs are low is the market more or less contestable?
More contestable
What type of efficiency are firms likely to be?
Productive and allocative efficient
What is the degree of contestability?
It’s measured by the extent to which the gains from market entry for a firm exceed the costs of entering the market. (Worth it or not)
What is a perfectly contestable market?
When a market has no sunk costs and no barriers to entry and exit. No market is likely to be perfectly contestable as there is always likely to be some sunk cost
