4.5 Contestable markets

• Contestable markets


  Markets that face actual and potential competition
• Characteristics of contestable markets


  • Entrants have free access to production techniques and technology
  • No significant entry or exit barriers
  • Low consumer loyalty
  • Number of firms in the market varies
• Allocative efficiency


  Firms operate at the bottom of the average cost curve in the long run
• Productive efficiency


  Firms are productively efficient in the long run
• Threat of new entrants

  Affects firms just as much as existing competitors
• Perfectly contestable markets are akin to a perfectly competitive market
• Firms can only earn normal profits in the short run in a contestable market
• Barriers to entry and exit

  • Legal barriers
  • Consumer loyalty and branding
  • Predatory pricing
  • Limit pricing
  • Anti-competitive practices
  • Vertical integration
  • Brand proliferation
  • Cost to write off assets and pay leases
  • Losing brand and consumer loyalty
  • Cost of making workers redundant
• Sunk costs


  Costs which cannot be recovered once they have been spent
• High sunk costs are likely to push a market towards a price and output that is similar to a monopoly
• Advantages of contestable markets

  • May lead to lower prices for consumers
  • Higher levels of competition may reduce the need for government intervention
• Disadvantages of contestable markets

  • Less likely to benefit from dynamic efficiency as firms will not earn supernormal profits