Contestability

Contestable market

A market with low barriers to entry/exit.

Contestability

How easy it is to enter a market.

E.g. the airlines market has low contestability because it’s tough to enter. 

E.g. the mango market has high contestability because it’s easy to enter.

What are examples of factors that affect contestablitly?

• high sunk costs

• barriers to entry

• anti competitive practises e.g vertical integration

Explain how vertical integration can be an anti-competitive practice:

Firms can vertically integrate to take control of scarce resources (like the power grid or the oil extraction firm); and then refuse to let new firms use these scarce resources, stopping them from entering the market.

in perfect competition and monopolistic competition, we see:

Many small sellers and buyers so high competition

oligopolies competition assumes:

a few large sellers so lower competition

market that isn’t contestable will have:

High barriers to entry e.g. high sunk costs and economies of scale

Hit & run competition

In contestable markets, if an incumbent firm is making supernormal profit in the short run, new firms will enter (or “hit”) industry.

They’ll undercut the incumbent firm to steal away its consumers and make supernormal profit.  

To get rid of the new entrants, the incumbent firm has to set price = AC so only normal profit can be made. New firm will then leave the market (“run”) because supernormal profit is gone. 

Explain what will happen to a perfect competition markets supernormal profit as we move into the long run. (4 marks)

Supernormal profits will incentivise new sellers to enter the market.

Because the star wars origami market is contestable (i.e. there are low barriers to entry/exit), new firms will enter the market and compete by undercutting Ted, stealing his consumers and making their own supernormal profit.

The only way to get rid of the new competitors is for the price = AC, so only normal profit can be made and the entrants have no reason to compete