Barriers to Entry

What are the key characteristics of contestable markets?

Contestable markets have actual and potential competition, free access to production techniques and technology, no significant entry or exit barriers, low consumer loyalty, and varying numbers of firms.

How do contestable markets affect firm behaviour?

Firms are more likely to be allocatively and productively efficient, operating at the bottom of the average cost curve due to the threat of new entrants (hit-and-run competition).

What happens to profits in contestable markets?

Firms can earn supernormal profits in the short run, but only normal profits in the long run as new firms enter the market, preventing sustained supernormal profits.

What is the purpose of barriers to entry?

Barriers to entry aim to block new entrants, increase producer surplus, and reduce contestability by making it harder for competitors to enter the market.

How do economies of scale act as a barrier to entry?

Firms exploiting economies of scale have a cost advantage over new entrants, making it difficult for them to compete.

How do legal barriers create obstacles for new firms?

Patents, exclusive rights, and licenses (e.g., taxi licenses) can prevent new firms from entering the market.

How does consumer loyalty and branding impact market contestability?

Strong consumer loyalty and branding make demand more price inelastic, reducing the likelihood of new entrants as consumers stick to established brands.

How does predatory pricing reduce contestability?

Firms set low prices to drive out existing competitors. As firms leave, remaining firms raise prices, reducing competition.

What is limit pricing and how does it affect entry?

Limit pricing involves setting prices low enough to discourage new entrants by making it unprofitable for them to compete.

What is an example of an anti-competitive practice that reduces contestability?

Refusing to supply retailers that stock competitors' products is one way firms can prevent competition.

How does vertical integration create barriers to entry?

It allows firms to control more of the market, gaining exclusive access to important technologies or resources, which blocks new entrants.

How does brand proliferation reduce market contestability?

Firms flood the market with multiple brands to disguise market concentration, making it harder for new competitors to gain market share.

What are some barriers to exit that prevent firms from leaving the market?

High costs to write off assets, pay leases, and make workers redundant can discourage firms from exiting the market, reducing contestability.

How did Amazon create barriers to entry with the Kindle?

Amazon lowered the price of the Kindle to gain market share in the short run, while exploiting exclusivity with workers and content to strengthen long-run market power.

What determines the degree of contestability in a market?

The degree of contestability depends on entry and exit costs, consumer loyalty, and barriers to entry, like sunk costs. While all markets have some potential for contestability, no market is perfectly contestable.

What are sunk costs and how do they affect contestability?

Sunk costs are costs that cannot be recovered once spent (e.g., advertising). High sunk costs make markets less contestable, as they increase the risks of entry and make it harder for new firms to compete.

How do industries like the bus and budget airline sectors demonstrate contestability?

In these industries, firms may have lower entry costs (e.g., renting planes), but recessions can make markets less profitable, affecting contestability. Government intervention can also help make industries like buses more contestable.

How do sunk costs affect market structure?

High sunk costs push markets toward monopoly-like conditions, as they increase risks and discourage new firms from entering, limiting competition.

What are internal economies of scale?

Internal economies of scale occur when a firm’s average costs fall as output increases. This allows larger firms to be more competitive and create barriers to entry for smaller firms.

How can a firm achieve internal economies of scale?

Firms can benefit from:

• Risk-bearing: Larger firms spread the cost of uncertainty across different products or services.

• Financial: Banks offer cheaper loans to larger firms, reducing their financing costs.

• Managerial: Larger firms can hire specialized managers, improving efficiency.

• Technological: Larger firms can invest in advanced machinery, lowering costs.

• Marketing: Marketing costs per unit are lower for larger firms as they spread the cost over more units.

• Purchasing: Larger firms can bulk-buy, reducing the per-unit cost of inputs.

What happens to average costs in the long run?

In the long run, average costs fall as a firm benefits from economies of scale. However, once the firm reaches the minimum efficient scale (the optimal output level), further increases in output can lead to diseconomies of scale, causing average costs to rise.

What is the minimum efficient scale (MES)?

The MES is the point at which a firm has fully exploited economies of scale and produces at the lowest possible average cost. It marks the optimal level of output for minimizing costs.