Contestability

Question 1

Contestability

Answer 1

How open a market is to new competitors

Question 2

Characteristics of a contestable market

Answer 2

• Perfect knowledge
• Free entry and exit
• All firms have the same AC as there are low sunk costs and easy access to technology
• Low product loyalty

Question 3

Examples of contestable markets

Answer 3

• AirBnB
• Five Guys
• Uber
• Ocado

Question 4

How does vertical integration affect contest ability

Answer 4

If a firm has access to the supply of a good then the market becomes less contestable

Question 5

Why is limit pricing used in contestable markets

Answer 5

Incumbent firms charge prices much lower than the profit maximisation even at a loss to deter fringe firms from entering the market, as if these firms entered the market they would take profits off of incumbent firms

Question 6

How efficient are firms in contestable markets

Answer 6

Tend to be statically efficient as they can only make normal profits in so produce at AC/MC=AR so are allocative efficient and they are productive efficient as they produce at the lowest AC point to stop new firms undercutting them with a lower AC

Question 7

Innocent entry barriers

Answer 7

Ones that occur naturally like high sunk costs or a natural monopoly

Question 8

Types of barriers to entry

Answer 8

• Legal Barriers
• Marketing Barriers
• Limit and predatory pricing
• High sunk costs
• Economies of scale for large incumbent firms allow low AC
• Trade restrictions

Question 9

Marketing Barriers

Answer 9

High levels of advertisement build up customer loyalty so the entry of new firms isnt a threat to incumbent ones

Question 10

Legal Barriers

Answer 10

Laws that make entry harder or impossible like patents to production or licenses

Question 11

Sunk cost

Answer 11

fixed cost that can never be recovered

Question 12

How is degree of contestability measured

Answer 12

Extent to which the gains from market entry outweigh the sunk costs

Question 13

Hit and Run tactics

Answer 13

Entering a market when supernormal profits can be made and then leaving once profits have been driven down to normal profits resulting in a net gain over the sunk costs

Question 14

How can technological change increase contestability

Answer 14

New technology can help put incumbent firms out of business in creative destruction, it may destroy old markets but create new more advanced ones

Question 15

Reasons for increased contestability nowadays

Answer 15

• Sunk costs are lower as many markets are digital and operate purely online
• Globalisation has allowed foreign firms to enter markets
• Predatory Pricing and cartels now illegal
• Recession provided new opportunities like Aldi and Lidl