Contestable Markets

Page 1

Contestable Markets

For a contestable market to exit there must be low barriers to entry and exit so that new suppliers can come into the market to provide fresh competition to established businesses

Contestable markets can have implications for the behaviour/conduct of existing (incumbent) firms and then affects the performance of a market in terms of allocative, productive and dynamic efficiency

Conditions for Market Contestability

1. Perfect information and the ability and/or right of all suppliers to make use of the best available production technology in the market

2. Freedom to advertise and enter a market with a competing product

3. Absence of sunk costs (no barrier to exit)

4. Low consumer loyalty

Examples of Contestable Markets

Fast food industry

Hotel rooms

Bookselling

Contestable Markets in Comparison with Perfect Competition

It is feasible in a contestable market that one firm have price-setting power and for firm in a market to produce a differentiated product

Incumbent firms behave as if there were intense competition

Increasing Market Contestability

Deregulation - opening up the market to more competition by reducing some of the statutory entry barriers

Competition policy - tougher competition laws against predatory behaviour by existing firms are designed to make markets more contestable

Barriers to Market Contestability

Internal economies of scale

Vertical integration - control of supply

Strength of customer & brand loyalty

Control of important technologies

Expertise and market reputation

Evaluation

The threat of new competition is often a powerful influence of the behaviour of existing established firms

A highly contestable market may resemble perfect competition, regardless of the number of firms, since incumbent firms behave as if there were intense competition

Competition policies that help to open up the market to new suppliers or persuade consumers to switch in greater numbers help to increase contestability

Terminology

Sunk costs - a cost that has already been incurred and cannot be recovered even if you leave the market e.g rent

Hit and run competition - occurs when a firm temporarily enters a market and then leaves when abnormal profits are exhausted. If the market is perfectly contestable, firms might wish to engage in some form of limit pricing to avoid the disruption of hit and run competition