contestable and non contestable markets Flashcards
when does a contestable market occur?
occurs when there is freedom of entry into a market and where costs of exit are low
contestable market and competition are different
what is a competition market based on?
based on the number of firms competing in a market
what is a contestable market based on?
based upon the threat of entrants
what are contestable markets characterised by?
-No barriers to entry or exit: barriers to entry and exit are low or non-existent. This allows firms to easily join or leave the market
-No competitive disadvantages on entry: new firms are able to setup & immediately compete with existing firms & have access to the same technology
-Perfect information: There is no proprietary knowledge that would limit competition (e.g. patents)
-Hit-and-run competition exists
what is are sunk costs?
an investment that been made but cannot be recovered
a sunk cost will be a barrier to entry and exit.firms will not be able to easily leave or join the market
E.g. To enter the industry, the firm may have acquired expensive assets that are highly specialised and difficult to resell
Other examples include money spent on advertising, research and development, branding etc.
what happens when sunk costs are high in a industry ?
it will limit competition and decrease contestability (freedom of entry into a market and where exit costs are low making it possible for new firms to enter) as firms will be more hesitant to enter
The lower the sunk costs, the more contestable the market
The higher the sunk costs, the less contestable the market
when does hit and run competition occur ?
occurs when a firm enters and exits an industry quickly
Firms are attracted by the short-run supernormal profit and once they have acquired these profits, they exit just as quickly
what is the significance of market Contestability?
The more contestable a market, the more the behaviour of existing competitors may be modified
E.g. Firms making supernormal profit may change their pricing strategy from profit maximisation (MC=MR) to limit pricing
They are even likely to set the price = average cost (AR=AC)
This will reduce hit and run competition
It will result in normal profit
There will be less disruption to the market
what does it mean when a market is more contestable?
the more the behaviour of firms resembles that of firm in perfect competition (a market structure where individuals have no market power due to the amount of competition and are unable to influence the price)
