LS14 : Contestability

Question 1

what are the conditions for a market to be considered contestable?

Answer 1

• no barriers to entry or exit
• no sunk costs

Question 2

define market contestability.

Answer 2

means that a market has freedom of entry and exit, creating permanent threat of competition. contestability requires low sunk costs. if an industry has high sunk costs, it creates a cost to leave and deters entry

Question 3

how has the internet changed contestability?

Answer 3

by making information more freely available, internet has given consumers improved knowledge of market conditions and enabled them to make more informed choices.
growth of online sales has made it easier for firms to enter markets

Question 4

what impact does contestability have on the performance of firms in an industry?

Answer 4

if a market is perfectly contestable then incumbent firms will have to remain efficient to protect themselves from “hit and run” competition. these incumbent firms are more productively and allocatively efficient so will make NP in the long run

Question 5

what is meant by sunk costs?

Answer 5

costs that cannot be recovered upon exiting a market. higher sunk costs increases the risk for entering a market

Question 6

what is “hit and run” competition?

Answer 6

disruptive firms who enter a market to take advantage of SNP, undercut the current firms and then leave once SNP is made

Question 7

what are the characteristics of a perfectly contestable market?

Answer 7

• low levels of SNP
• high degree of price competition
• low brand loyalty
• cost-cutting activities
• new firms joining and existing firms leaving

Question 8

why can it be argued that the supermarket industry is contestable?

Answer 8

• some price competition
• new firms entering market
• falling profits

Question 9

why can it be argued that the supermarket industry is not contestable?

Answer 9

• some brand loyalty
• relatively high profits being made
• high barriers to entry (purchasing EOS)

Question 10

what are barriers to entry?

Answer 10

factor which makes it harder and riskier to enter a market (structural, strategic, statutory)

Question 11

give five barriers to entry.

Answer 11

• economies of scale
• existing brand loyalty
• high start up costs
• patents
• regulation
• limit pricing

Question 12

what is limit pricing?

Answer 12

incumbent firms who are enjoying large EOS can choose a price which allows them to make SNP, but low enough that new firms cannot compete on price unless they enter with a high level of output