Contestable Markets Flashcards
What is a Contestable Market?
One where there is a threat of competition enough to influence and change the beaviour of firms
What are the characteristics of a Contestable Market?
- Low barriers to entry & exit
- Large pool of competitor threat
- Good information
- Incumbent firms are subject to ‘hit and run’ competition
What is ‘Hit and Run’ Competition?
Potential competitors enter the market, snatch supernormal profits and exit the market before existing firms are able to react
How has technology reduced the barrier to entry and exit?
- Firms do not need to be physical which reduces start up and sunk costs
- Reduced need for excessive labour allowing bypass of regulations
- Easier advertising to enhance brand loyalty
- Technical Economies of Scale
How has technology increased the pool of entrants?
- Allowing greater innovation
- Allowing cheaper production methods
How has technology improved information?
- Through the internet, firms are able to gain information about costs and market dynamics easily
- Improved communication
How does Contestability affect the behaviour of a Monopoly?
A Monopoly will shift production from MC=MR to AC=AR, known as the limit price and breakeven point, sacrificing some supernormal profits for normal profits
Why does a Monopoly move to AC=AR in a contestable market situation?
- To eliminate the threat competition by reducing profit margins
- To prepare themselves for actual competition with lower prices and higher quantities
What are the advantages of a Contestable Market?
- Static Efficiency
- Job Creation
What are the disadvantages of a Contestable Market?
- Lack of Dynamic Efficiency
- Creative Destruction
- Anti-Competitive Tactics
- Cost Cutting in Dangerous Areas
What are some evaluation points to consider about a Contestable Market?
- Short Run vs Long Run
- Length of Contestability
- Regulations
- Technology as a counterargument
- Extent of lack of Dynamic Efficiency
How do you argue the Short Run vs Long Run?
Static Efficiencies may be prevalent in the SR, but not in the LR as firms may use anti-competitive strategies such as predatory pricing, limit pricing, flooding the market or mergers, which can erode static efficiency gains & contestability in the LR.
How do you argue Technology as a factor?
- Innovations and advancements can be patented
- Internet increases the availability of market information which can be used for price discrimination tactics
