Contestable & Non Contestable Markets

Question 1

Characteristics of Contestable Markets

Answer 1

• Contestable markets face actual & potential competition
• Entrants have free access to production techniques & technology
• No significant entry or exit barriers to the industry (e.g no sunk costs)
• Low consumer loyalty
• No. of firms in the market varies

Question 2

Significance Contestable Markets

Answer 2

• Firms are more allocatively efficient, LR, productively efficient
• Threat of new entrants affects firms, due to low barriers to entry
• Similar to perfectly competitive market
• Could be supernormal profits in SR, normal profits in LR
• In SR, new firms can enter & take advantage of supernormal profits
• However, firms only earn normal profits in SR as is the only way to prevent potential competition
• Without supernormal profits, no incentive for new firms to enter, even if barriers to entry & exit are low

Question 3

Types of Barriers To Entry

Answer 3

• Economies of Scale: New firms enter the market, can’t compete as costs of prduction are higher
• Legal Barriers: E.g patents, exclusive rights to production, market licences to operate (e.g taxi industry)
• Consumer Loyalty & Branding: Makes demand becomes more price inelastic, consumers less likely to try other brands
• Vertical Integration: 1 firm gains control of more of the market, (e.g gaining control of important technologies, prevent other firms gaining access to them)
• Brand Proliferation: Disguises market concentration (e.g many brands of the laundry soap market provided by few large conglomerates)

Question 4

Types of Barriers To Exit

Answer 4

• Cost to Write Off Assets & Pay Leases: Have to continue paying leases and contracts, even after closure, could be cheaper to stay in industry than to leave
• Losing Brand & Consumer Loyalty: Hard to put a monetary value on, considered a cost of leaving the market.
• Cost of Making Workers Redundant: Discourage firms from leaving an industry

Question 5

Sunk Costs

Answer 5

Sunk Costs: Costs which cannot be recovered once they have been spent
- E.g advertising
- A market with high sunk costs is less favourable as higher risk
- High sunk costs are likely to push a market towards a price & output that is similar to monopoly