Contestable and non-contestable markets Flashcards
What defines a contestable market?
A contestable market is one where firms can enter and exit freely, facing low or no sunk costs, which allows potential competition to influence the behavior of existing firms.
What characterizes a contestable market?
1) Low barriers to entry/exit
2) Large pool of potential entrants
3) Good information (costs and tech)
4) Incumbent firms subject to Hit and run competition
What characterizes a non-contestable market?
A non-contestable market has high barriers to entry and exit, such as significant sunk costs, making it difficult for new firms to enter and for existing firms to leave
How does market contestability affect industry performance?
In contestable markets, the threat of potential entrants forces incumbent firms to act competitively, leading to lower prices, improved products, and increased efficiency.
What are sunk costs?
Sunk costs are expenses that cannot be recovered once incurred, such as specialized equipment or advertising campaigns, which can deter firms from entering or exiting a market.
What is hit-and-run competition?
Hit-and-run competition occurs when firms enter a market to exploit short-term profits and then exit quickly, often due to low sunk costs and the threat of potential competition.
Where would a contest able market operate?
At (AC=AR) as this eliminates the threat since it decreases the profit margins and equally means that firms are prepared if fats become real since price decreases and quantity increases.
Pros of contestable markets?
Closer to allocative efficient, productive, efficient and efficient and will create jobs. It is an exactly at the point of these efficiencies however the firm moves towards all of these.
Cons of contestable markets?
Lack of dynamic efficiency due to lower profits along with cost cutting in dangerous areas and potentially creative destruction as a result of non-price competition and anti-competitive strategies such as predatory pricing.
What are some evaluation points for contestable markets?
1) Length of Contestability: The duration a market remains contestable depends on factors like technological advancements and regulatory changes, which can either extend or reduce the period during which firms can enter and exit freely
2) Role of Technology: Technological advancements can improve the contestability of a market by reducing entry and exit barriers, enabling new firms to enter more easily and existing firms to exit without incurring significant costs.
3) Regulation: Regulatory frameworks can either facilitate or hinder market contestability; for instance, deregulation can lower entry barriers, while stringent regulations can increase them, affecting the ease with which firms can enter or exit a market.
4) Dynamic Efficiency: In contestable markets, firms are incentivized to innovate and improve efficiency to deter potential entrants, leading to dynamic efficiency over time.
What is an example of a contestable market?
A taxi service is an example of a contestable market because it has low barriers to entry and exit, allowing new firms to easily enter and challenge existing providers, which keeps prices and service competitive and little sunk costs (you can just rent a car in theory as you go)
