Contestable Markets

Question 1

Briefly, what is a contestable market?

Answer 1

A contestable market is a recent theory of market structure which bas based on the likely which potential new entrants could have on the price and decisions of incumbent firms.

There are no barriers to entry and entry and exit is costless.

Sunk costs are not present.

Question 2

In a contestable market, is entry free and exit costless?

Answer 2

Yes!

Question 3

Give six reason as to why the airline market is not contestable

Answer 3

1. Sunk costs are prevalent. - Lots of marketing is needed to persuade passengers onto a new airline
2. Airport landing slots are often constrained by both time and physical space. Most of these are often held by large incumbent airlines who have ‘Grandfather rights’
3. There is a strong element of brand loyalty through frequent flier programmes (FFPs)
4. Bilateral agreements and other restrictions apply to aviation. The European market is more contestable as there is an open trade area
5. The technology to make some routes economically viable may not be readily available, for example, lots of “long and thin” routes are only viable through the 787 Dreamliner
6. There are barriers to exiting the market (exiting routes)

Question 4

Why may aviation be argued as a contestable market?

Answer 4

Because new entrants can lease an aircraft and “cream off” profits and then leave when the incumbent airlines finally react. Also known as “hit and run”.

In reality though, aviation is not a contestable market as there are many sunk costs.

Question 5

What four barriers are there to an airline leaving a market?

Answer 5

1. The airline may continue to serve a market to avoid bad PR
2. The airline may continue to operate unprofitable smaller routes which feed longer routes
3. They might want to keep their valuable slots
4. If they withdraw from a route it allows their competitors to enhance their position