Contestable markets

• 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