Entry Barriers Flashcards
What is an incumbent firm?
One that is already well established in the market
How do sunk costs create a barrier to entry?
They represent an expense that cannot be recuperated by firms if they decide to leave the market. This makes it risky and potentially costly for new firms to enter. Also some firms may not be able to pay it in the first place
How can even super small sunk costs create a barrier to entry?
because they anticipate post-entry price competition leading to losses, essentially creating an entry barrier Even if a firm can partially recover sunk costs, the anticipation of aggressive pricing post-entry can still create a significant entry barrier.
Why might contestable markets not hold in reality?
Since it assumes no sunk costs but in reality there is likely to be some sort of sunk cost
What is a contestable market?
One where firms are subject to ‘hit-and-run’ entry, and there are no sunk costs for entry and exit, allowing for potential entrants to costlessly enter and exit the industry.
What is the significance of ‘hit-and-run’ entry in contestable markets?
‘Hit-and-run’ entry refers to the ability of a firm to enter the market quickly, take advantage of higher prices, and then exit just as quickly if it becomes unprofitable, ensuring the incumbent behaves competitively.
What is a feasible industry configuration in a contestable market?
A feasible industry configuration is when the incumbent’s price and quantity produced allow it to cover costs and make a non-negative profit.
What makes an industry configuration sustainable in a contestable market?
It is sustainable if no potential entrant can profit by undercutting the incumbent’s price, ensuring that the incumbent can’t be profitably displaced by a new entrant.
What does the contestable-markets theory suggest about regulatory intervention?
The theory suggests that markets without entry barriers do not need regulatory intervention, as the threat of entry ensures competitive behaviour by the incumbent firm.
How do sunk costs affect the contestability of a market?
Sunk costs create entry barriers. Even small sunk costs can deter entry, as potential entrants face the risk of not recovering these costs, leading to a sustained monopoly.
How much profit do firms make under the contestable market theory?
zero, AC pricing occurs
Why can sunk costs create a barrier to entry?
They represent a risk for new entrants. If a business fails, these costs cannot be recovered, which makes entering the market more risky, especially if the incumbent firms can lower their prices to a level where the entrant cannot recover the sunk costs.
Why should markets with increasing returns technology (C(q) = F + cq) not be heavily regulated, if contestable?
Because the threat of potential entry limits the power of incumbents to set prices above competitive levels, leading to a naturally efficient outcome without the need for regulation- in simple terms - If this kind of market is easy for new companies to get into or leave without losing a lot of money (we say it’s “contestable”), then the companies already in the market have to keep their prices fair. They know that if they try to charge too much, new companies will jump in, start selling at lower prices, and grab their customers. So, the big players stay honest with their pricing because they’re always a little worried about new competition. That means things naturally work out well, and you don’t need a bunch of extra rules and regulations to keep prices down—the potential for competition does that on its own.
How does the level of product differentiation and the intensity of competition affect the social desirability of free market entry?
High Differentiation & Fierce Competition: More entry is beneficial, as it promotes innovation and offers unique products, potentially leading to insufficient entry from a social perspective.
Low Differentiation & Soft Competition: More entry might lead to excessive businesses that merely steal business from others without adding value, resulting in excessive entry from a social perspective. This can clutter the market and reduce overall economic efficiency
