3.4.7

• a contestable market is one that is open to actual and potential competition
• contestable markets means there are low to no barriers to entry and exit
• characteristics of contestable markets: freedom of entry/ exit, no large sunk costs, all firms have same access to technology, firms can hit and run, competitive nature discourages firms entering
• hit and run entry is where a firm enters the market, makes short term profits, and then exits easily
• firms in contestable markers are more competitive because of the constant threat of new firms entering
• limit pricing - setting prices low enough to make the market less attractive
• firms in contestable firms lower profits in the long run - due to the threat of new entry firms eroding any supernormal profits
• firms in contestable markets have the incentive to innovate - improving their products allows firms to stay competitive and create barriers to entry
• barriers to entry and exit: economies of scale, advertising, brand loyalty, sunk costs
• sunk costs are costs that cannot be recovered
• sunk costs help show how contestable a market is
• if sunk costs are high, firms are less likely to enter the market because leaving would result in heavy losses
• high sunk costs - less contestable market
• a contestable market is only with low entry and exit barriers - allows for easy market access
• in contestable markets, the threat of potential competition keeps prices low and forces firms to earn only normal profit
• hit and run competition occurs when a firm enters a market temporarily to make supernormal profits and then leaves
• contestability increases productive efficiency because firms are under pressure to reduce waste and costs
• firms are more likely to enter a market if sunk costs are low, because they won't lose much money if they decide to leave
• normal profits is the minimum profit needed to keep resources in their current use
• normal profits covers opportunity costs