contestability

Question 1

what is contestability based on?

Answer 1

based around potential threat of competition

Question 2

what are the characteristics of contestability?

Answer 2

• absence of entry/exit barriers
• pool of potential entrants
• perfect information
• incumbents vulnerable to hit + run competition as they have no cost advantage over hut and run entrants
• no sunk costs
• exit/entry must be rapid
• normal profits are made

Question 3

how does the absence of entry/exit barriers make a market more contestable?

Answer 3

• increases the threat of entry
• makes the market contestable
• firms are willing to compete
• firms attracted to supernormal profit in the market

Question 4

what is an incumbent firm

Answer 4

firms that are already in the market

Question 5

what is hit and run competition

Answer 5

hit + run competition is when new firms come in and they grab some of the supernormal profits being made in the short run and then leave the market

Question 6

if a market is perfectly contestable how will an incumbent firm react?

Answer 6

• firms know its risky to make supernormal profit as it would incentivise new entry
  
  • would think to reduce their supernormal profits
• firms would go to the point of normal profit where AR=AC

Question 7

what is the entry limit price

Answer 7

firms would go to the point of normal profit where AR=AC

Question 8

why does AC=AR in a contestable market

Answer 8

eliminate threat by dec profit margin
prepared if threat becomes real as prices are low and quantities are high

Question 9

whats the difference between a competitive market and a contestable market?

Answer 9

competitive market- is about actual competition

contestable market is about potential threat

Question 10

why may contestable markets be good?

Answer 10

• the more contestable the markets are, the more the outcomes are like competitive outcomes
  
  • price dec, quantity inc
• allocative + productive efficiency
  
  • if firms want to be competitive they have to be as efficient as possible to negate the threat
• inc in consumer surplus
• job creation
• x-efficiency
• competition policies such as liberalisation of a market can help to open up an industry to new suppliers or persuade consumers to switch in great numbers to help to increase contestability

Question 11

how can you evaluate contestable markets?

Answer 11

• supernormal profits wont be made
• lack dynamic efficiency?
• if new firms come in with innovative ideas, that itself is the benefit of dynamic efficiency
• may not be a big decrease in prices
• cost cutting may be taken place in undesirable ways
  
  • e.g cutting wages
• when new firms come in they may destroy existing firms
• may lead to job losses
• anti competitive strategies

Question 12

how could you evaluate the point that contestability could lead to job losses?

Answer 12

if large new firms enter the new market, then where jobs have been destroyed, those workers can move to the new firms and still work in the same industry

Question 13

what could anti competitive strategies lead to?

Answer 13

could lead to static inefficiencies

Question 14

what do the effects of contestability depend on?

Answer 14

• length of contestability
• role of technology
  
  • can improve info acquiring consumer data
  • may lead to price discrimination
• regulation
  
  • minimise cost cutting in dangerous areas
  • protect product standards, health and safety etc
• dynamic efficiency

Question 15

what are sunk costs and give examples

Answer 15

costs that a firm cant recover
e.g asset write-offs
closure of project cncellation costs
loss of business reputation and goodwill

Question 16

what is the impact of the internet on contestability

Answer 16

improved knowledge and information of market conditions
online sales make it easier for new firms to enter
this makes it easier for new firms to enter the market

Question 17

how may firms deter entry of new firms into the market

Answer 17

predatory pricing
limit pricing
raise fixed costs e.g advertising and R+D, vertical integration

Question 18

what policies can be used to increase contestability

Answer 18

govt can subsidise firms to start up
deregulation of an industry
tough rules on predatory pricing
encouraging international trade

Question 19

recall some examples of contestable markets

Answer 19

fast food industry
hotel/ room sharing sector
private education
bookselling
city transport services