Contestable markets

Question 1

features of contestable market

Answer 1

• face threat of actual and potential competition
• entrants have free access to production techniques and tech
• no barriers to entry or exit
• good info
• large pool of potential entrants= constant comp entering market
• ‘hit and run’ comp for incumbent firms due to low barriers to entry and exit
  = enter quickly to snatch supernormal profit before incumbent firms can change price to react, then leave market
• no sunk costs

Question 2

how does tech affect contestable markets

Answer 2

• tech decreases barriers to entry and exit
  = businesses don’t have to be physical
  = reduces sunk costs and start up costs= don’t have to hire as many workers
  = don’t need to meet as many regulations
• easier to achieve technical EoS= reduces LRAC
• tech has high pool of potential entrants= increased innovation
  = new firms enter w smthing new to disrupt markets= risk creative destruction
• allows firms to find cheaper ways of producing goods
  = find low COP methods to disrupt existing firms= increase pool of potential entrants
• tech has high info due to internet= get info on costs of market etc and easier communication to gain info

Question 3

impact of contestable market

Answer 3

• if there’s a strong threat of entry, monopolist wld move to AC=AR
  = breakeven point of normal profit
  = decrease profit margins to eliminate threat from new firms
  = decrease incentive to enter market= limit actual threat of comp
• by lowering price and increasing Q, firm is prepared to to compete w lower prices against other firms
• contestable incumbent markets worried about new firms entering due to incentive of supernormal profit
  = they produce @ normal profit

Question 4

adv contestable market

Answer 4

• allocative efficiency= decrease P and increase choice
• productive efficiency= increase EoS= decrease costs and price
• low x-inefficiency= low waste
• high job creation as labour is a derived demand

Question 5

disadv contestable market

Answer 5

• lack of dynamic efficiency due to low profit margins= only normal profit made
• risk of cost cutting in dangerous areas like health and safety, wages etc
• creative destruction due to new firms entering and innovating
  = increase job losses BUT those workers could still move to new, replacing firms in same industry
• anti-comp strategies in LR like heavy advertising, price flooding, predatory pricing etc
  = contestability won’t last in LR= result in static inefficiencies

Question 6

evaluation of contestable markets

Answer 6

• length of contestability= in LR use of anti-comp strategies won’t be contestable
• depends on role of tech= use of patents copyrights decrease contestability
• depends on levels of regulation
  = high reg decreases issues of cost cutting and anti-comp strategies to protect contestability
• depends on sunk cost levels e.g. advertising= barrier to contestability