Contestable Markets Flashcards
What must be present in a market for it to be contestable
No barriers to entry or exit
No sunk costs
What are sunk costs
Costs that a firm incurs in setting up a business and which cannot be recovered if the firm exits the market
What can’t a firm do in a contestable market and why
Set a price higher than average costs - if it does it will open up the possibility of hit and run entry by new firms
What is hit and run entry for a firm
When a firm enters a market and competes away the supernormal profits
What must new firms have in a contestable market
No competitive disadvantage - have access to the same technology and have no significant learning by doing effects
Entry and exit must be rapid
What happens when a monopolist charges the profit-maximising price given the market is contestable
The firm will be vulnerable to hit-and-run entry
Is productive efficiency achieved in a contestable market
No
Is allocative efficiency achieved in a contestable market
No
How has the growth of the internet affected contestability in markets
Information is more freely available - consumers can make more informed choices
Firms can enter the market easier with online sales
What are some entry deterrence strategies
Pricing
Advertising and Publicity - More money spent on advertising makes it harder for new firms to become established - helps build consumer loyalty
R + D - New firms wanting to enter the market need to invest heavily in R+D
Define a contestable market
When an entrant has access to all production techniques available to the incumbents is not prohibited from taking the incumbent’s customers, and entry decisions can be reversed without cost
What is Tacit Collusion / Informal Collusion
Co-operation that is implicit or understood between the co-operating firms, without a formal agreement
What are the objectives of tacit collusion
Co-ordinate prices
Avoid competitive price-cutting
Limit competition
Reduce uncertainties
Increase profits
What is Price leadership
A type of informal collusion where a dominant firm in the industry sets a price and also initiates any price changes - remaining firms become price takers
Obstacles faced with price leadership
Cost differences between firms particularly in cases where there is significant product differentiation
Some firms may not follow the leader
Firms face the incentive to cheat by lowering prices to capture market share and increase profits
High industry profits may bring new entrants who cut into market shares and profits
Price leadership may not be legal in some areas
