Contestable and non-contestable markets

Question 1

Define competition within a market

Answer 1

Competition refers to the number of firms competing in a market

Question 2

State what how we know competition is high or low for a firms

Answer 2

• Competition is higher if there are lots of firms competing
• Competition is lower is there are a few firms competing

Question 3

Are there high barriers to entry and exit in a contestable market

Answer 3

No - It should be easy for new firms to enter and contest incumbent firms

Question 4

State the characteristics of a contestable market

Answer 4

• low sunk costs
• low economies of scale
• low barriers to entry/ Exit

Question 5

What type of profit do firms make in a contestable market in the short run

Answer 5

Supernormal profits

Question 6

State how supernormal profits in a contestable market may leave a firm open to hit and run competition

Answer 6

supernormal profit will incentivise new firms to enter the industry and because the market is contestable, there are low barriers to entry/exit, so it will be easy for new firms to enter.
New firms will therefore enter (or “hit”) the industry. They’ll undercut the incumbent firm to steal away its consumers and make supernormal profit.

Question 7

How may firms get rid of hot and run competition

Answer 7

the incumbent firm has to set price = AC so only normal profit can be made.
- The new firm will then “run”: they will leave the market because all the supernormal profit is gone.