Contestable markets

• Contestable markets


  • Face actual and potential competition
  • Entrants have free access to production techniques and technology
  • No significant entry or exit barriers
  • Low consumer loyalty
  • Number of firms varies
• If markets are contestable

  • Firms are more likely to be allocatively efficient
  • Firms operate at the bottom of the average cost curve (productively efficient)
• Threat of new entrants

  Affects firms just as much as existing competitors
• Highly contestable markets


  Akin to a perfectly competitive market
• In the short run

  • There could be supernormal profits
  • New firms can enter and take advantage of the supernormal profits
• In the long run

  Firms can only earn normal profits
• No markets are perfectly contestable, markets generally have some degree of contestability
• It is hard to judge the degree of contestability, since in reality there will be some costs to entry and exit
• Applications of contestability


  • Bus industry (government helps make more contestable)
  • Budget airline industry (firms rent planes for a few years and then sell them, Ryanair entered cheaply by choosing less popular landing slots)
• Sunk costs


  Costs which cannot be recovered once they have been spent
• High sunk costs


  Likely to push a market towards a price and output that is similar to a monopoly
• Sunk costs are a barrier to contestability