Contestable Markets

Question 1

Explain the characteristics of a contestable market

Answer 1

Actual and Potential competition

Free access to production techniques and technology

No significant barriers to entry or exit

Low consumer loyalty

Number of firms in the market varies

Question 2

2. Behaviour of firms in a contestable market/
   Explain productive and allocative efficiency in a contestable market

Answer 2

• Contestable markets cause firms to be allocativley efficient. And in the LR firms produce at the bottom of their AC curve causing them to be productivley efficient
  • Firms are wary of new firms entering the market and taking the supernormal profits then leaving due to low barriers to entry and exit. (Hit and Run competition)
  • Highly contestable markets are very similair to perfectly contestable markets, as they act as though there is a large amount of competition as a result they become productively efficient and allocatively efficient in the LR

Firms stay at normal profits in SR and LR to stop incentives for new firms joining

Question 3

Types of Barriers to entry

Answer 3

Economies of Scale

Legal Barriers

Consumer loyalty and Branding

Predatory pricing

Limit pricing

Question 4

Types of Barriers to exit

Answer 4

The cost of write off assets and leases

Losing a brand

The costs of making workers redundant

Question 5

Evaluate the Advantages of a contestable market

Answer 5

May lead to lower prices for consumers due to the high levels of competition

High levels of competition reduce the need for government intervention

Question 6

Evaluate the disadvantages of a contestable market

Answer 6

Less likely to benefit from dynamic efficiency as firms will not earn supernormal profits in either SR or LR.