contestable markets Flashcards
what is a contestable market
when there is freedom of entry and exit into the market
what do incumbent firms have access to
all production techniques
what do incumbent firms want to do
eliminate threat of new market entrants
what type of profit is made in the short term
supernormal
what type of efficiency does this lead to
dynamic
what’s a real life example of short term dynamic efficiency
Fintech startups such as Monzo and Revolut have driven innovation in the UK banking sector, offering digital banking solutions and incentivizing traditional banks like Lloyds and Barclays to innovate
what type of profit is made in the long run
normal
why is this
because incumbent firms want to ensure new entrants are unprofitable so make sure the price is as low as possible so they cant come in and take their consumers, profit, undercut prices and market share
what are the characteristics of contestable markets (5)
no consumer loyalty
no barriers to entry and exit (particularly no sunk costs)
Large pool of potential entrants to the market
Consumers have perfect knowledge of the prices being charged in a market
Producers have perfect information of costs and technology in the industry and the prices that other firms charge
Incumbent firms are vunrable to hit and run competition
what is the ‘hit and run’ strategy
firms may exploit short term profit opportunities without long-term commitments as they take advantage of high supernormal profits and then leave the market
what is predatory pricing
anywhere below AC curve on diagram
make a loss in the short run but long run put prices back up and regain profits
an illegal pricing strategy as it distorts efficiencies, anti-competitive behavior which ultimately is a market failure as they will just raise prices in the long run creating monopolistic conditions
what is price limiting
main pricing strategy used. Make it unprofitable for new firms deterring entry. set price at same level as AC to avoid attracting ‘hit and run’ comp
what is a contestable market (definition)
when an entrant has access to all production techniques available to incumbent firms and entry decisions can be reversed without costs
what are sunk costs
sunk costs cannot be recovered if a business decides to leave an industry. the existence of sunk costs makes a market less contestable
whats an example of hit and run strategy being used irl
In 2018, Norwegian Air aggressively launched long-haul budget flights from Europe to the U.S., targeting transatlantic routes where major airlines earned significant profits.
Norwegian entered with low fares, forcing competitors like British Airways and Delta to lower their prices.
However, once competition intensified and profits diminished, Norwegian withdrew from the market (exiting transatlantic flights in 2021), exemplifying the “hit and run” strategy.
This type of market behavior is common in industries with low barriers to entry and exit, where firms can exploit short-term profit opportunities without long-term commitments.
