Contestability Flashcards
Contestability
How open a market is to new competitors
Characteristics of a contestable market
- Perfect knowledge
- Free entry and exit
- All firms have the same AC as there are low sunk costs and easy access to technology
- Low product loyalty
Examples of contestable markets
- AirBnB
- Five Guys
- Uber
- Ocado
How does vertical integration affect contest ability
If a firm has access to the supply of a good then the market becomes less contestable
Why is limit pricing used in contestable markets
Incumbent firms charge prices much lower than the profit maximisation even at a loss to deter fringe firms from entering the market, as if these firms entered the market they would take profits off of incumbent firms
How efficient are firms in contestable markets
Tend to be statically efficient as they can only make normal profits in so produce at AC/MC=AR so are allocative efficient and they are productive efficient as they produce at the lowest AC point to stop new firms undercutting them with a lower AC
Innocent entry barriers
Ones that occur naturally like high sunk costs or a natural monopoly
Types of barriers to entry
- Legal Barriers
- Marketing Barriers
- Limit and predatory pricing
- High sunk costs
- Economies of scale for large incumbent firms allow low AC
- Trade restrictions
Marketing Barriers
High levels of advertisement build up customer loyalty so the entry of new firms isnt a threat to incumbent ones
Legal Barriers
Laws that make entry harder or impossible like patents to production or licenses
Sunk cost
fixed cost that can never be recovered
How is degree of contestability measured
Extent to which the gains from market entry outweigh the sunk costs
Hit and Run tactics
Entering a market when supernormal profits can be made and then leaving once profits have been driven down to normal profits resulting in a net gain over the sunk costs
How can technological change increase contestability
New technology can help put incumbent firms out of business in creative destruction, it may destroy old markets but create new more advanced ones
Reasons for increased contestability nowadays
- Sunk costs are lower as many markets are digital and operate purely online
- Globalisation has allowed foreign firms to enter markets
- Predatory Pricing and cartels now illegal
- Recession provided new opportunities like Aldi and Lidl
