contestability

Question 1

what is contestability

Answer 1

the extent to which firms can enter or leave a market without cost

Question 2

what are some implications of a contestable market

Answer 2

incumbents face the threat of competition from potential entrants esp if they make large snps and so they take into account the likely response of rivals when setting their price.
-incentive to set their prices lower to deter new entrants and hiding their snp

Question 3

how can deregulation lead to greater contestability

Answer 3

removing legal barriers to entry makes it easier for new firms to join a market and challenge incumbents

Question 4

what are some benefits of contestability

Answer 4

1) cut prices=inc consumer surplus
2) earn normal profit to avoid new competition

Question 5

what are some drawbacks of contestability

Answer 5

1)lower snp reduces funds available for R&D=loss of dynamic efficiency
2)more firms in industry=loss of eos so higher LRAC and higher prices
3)more services=more negative externalities eg buses

Question 6

if there are low barriers to entry what does this mean in terms of contestability

Answer 6

more contestable

Question 7

what is the hit and run tactic

Answer 7

entering a market while snp can be made and then leaving the market once prices have been driven down to normal profit levels

Question 8

explain how incumbent firms may act if there is high contestability

Answer 8

1)they know that snp will attract new entrants so they may sacrifice short term profits and set lower prices to avoid new firms entering as this may be the best way to maximise profit in the long run
2)they will also try creating high barriers to entry if they can eg heavy spending on advertising or make it clear that they will use predatory pricing if they have to