Contestable markets

Cards (9)

  • Contestable market

    A market where there is a threat of competition, not necessarily actual competition, but the threat could be enough to affect the behavior of firms in the market
  • Characteristics of a contestable market

    • Lower barriers to entry and exit
    • Large pool of potential entrants
    • Good information of market conditions so new firms can compete on a level playing field
    • Incumbent firms are subject to hit and run competition due to low barriers to entry and exit
  • Technology has increased the contestability of markets by reducing barriers to entry and exit, allowing for greater innovation and disruption, and improving information
  • In a contestable monopoly market
    The monopolist will move to the limit price (where average cost equals average revenue) to eliminate the threat of entry and competition, even though they could charge a higher monopoly price
  • Outcomes of a contestable market
    • Lower prices
    • Higher quantities
    • Competitive outcomes similar to a perfectly competitive market (allocative, productive, and X-efficiency)
  • Potential issues with contestable markets
    • Lack of dynamic efficiency over time
    • Concerns about cost-cutting in dangerous areas like health, safety, and the environment
    • Creative destruction leading to job losses
    • Anti-competitive strategies by incumbent firms to eliminate the threat of entry
  • The length of contestability, the role of technology, and the role of regulation are important factors to consider when evaluating the pros and cons of contestable markets
  • Regulation can help minimize the issues of cost-cutting in dangerous areas and anti-competitive strategies in contestable markets
  • Evaluating the level of innovation in a contestable market can help assess its dynamic efficiency