Contestability

Question 1

Contestable market

Answer 1

A contestable market is one with a high threat of new entrants which keeps firms producing at a competitive level.

Question 2

Characteristics of a contestable market

Answer 2

• Perfect knowledge
• Freedom of entry and exit
• Low product loyalty
• Profit maximisers

Question 3

Implications of high contestability

Answer 3

• The use of limit pricing by firms
• Firms can only make normal profits in the short run
• Likely productive and allocative efficiency

Question 4

Sunk costs definition

Answer 4

A fixed cost that a business cannot recover if it leaves the industry.

Question 5

How to measure contestability

Answer 5

Degree of contestability is measured by the extent to which the gains from market entry for a firm exceeds the cost of entering the market.

Question 6

Perfectly contestable market

Answer 6

• No sunk costs

- No barriers to entry/exit

Question 7

Reasons for increasing contestability

Answer 7

• Deregulation
• Competition policy- less pred pricing (illegal)
• EU single market
• Rise of the internet- improved information

Question 8

Evaluation of contestability

Answer 8

• It’s difficult to measure
• Depends on cost structure of different firms
• Degree of contestability
• Regulation
• Level of technology

Question 9

How technology has increased contestability?

Answer 9

• Reduces barriers to entry
• Reduces start up costs
• Less workers needed- less regulation
• Technical economies of scale
• Easier to advertise
• Improved innovation

Question 10

How threat of entry affects monopoly behaviour?

Answer 10

• Move towards AC=AR

- Improves competitivity

Question 11

Disadvantages of high contestability

Answer 11

• Lack of dynamic efficiency
• Cost cutting in dangerous areas
• Anti-competitive strategies