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F) Contestability

The document discusses contestable markets and their characteristics. It notes that in contestable markets, there are no significant barriers to entry or exit, firms face actual and potential competition, and consumers have low loyalty. This implies that firms in contestable markets will operate efficiently and act as if there is more competition than actually exists to prevent new entrants. However, markets differ in their degree of contestability depending on sunk costs and switching costs. The bus and budget airline industries are provided as examples of industries with some contestability.

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17 views

F) Contestability

The document discusses contestable markets and their characteristics. It notes that in contestable markets, there are no significant barriers to entry or exit, firms face actual and potential competition, and consumers have low loyalty. This implies that firms in contestable markets will operate efficiently and act as if there is more competition than actually exists to prevent new entrants. However, markets differ in their degree of contestability depending on sunk costs and switching costs. The bus and budget airline industries are provided as examples of industries with some contestability.

Uploaded by

Charlie Delta
Copyright
© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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Edexcel​ ​Economics​ ​A-level

Unit​ 3
​ :​ ​Business Behaviour

Topic​ ​3:​ Market Structures and


Contestability
3.6 Contestability

Notes

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Characteristics of contestable markets:

Contestable markets face actual and potential competition.


Entrants to contestable markets have free access to production techniques and
technology.
There are no significant entry or exit barriers to the industry. For example, there will
be no sunk costs in a contestable market.
There is low consumer loyalty.
The number of firms in the market varies.

Implications of contestable markets for the behaviour of firms:

If markets are contestable, firms are more likely to be allocatively efficient. In the
long run, firms operate at the bottom of the average cost curve. This makes them
productively efficient.
The threat of new entrants affects firms just as much as existing competitors. Due to
the low barriers to entry which provide easy access to the market, firms are wary of
new entrants entering the market, taking supernormal profits, and then leaving.
Markets which are highly contestable are akin to a perfectly competitive market.
This is because existing firms act as though there is a lot of competition.
There could be supernormal profits in the short run and only normal profits in the
long run. In the short run, new firms can enter and take advantage of the
supernormal profits. However, in practice, firms can only earn normal profits in the
short run. This is because it is the only way to prevent potential competition.
Without supernormal profits, there is no incentive for new firms to enter, even if
barriers to entry and exit are low.

Sunk costs and the degree of contestability:

There are different degrees of contestability across markets. All markets have the
potential to be contestable, but it depends on what kind of costs firms face, and how
loyal consumers are. 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.
An application point of contestability could be the bus industry, which the
government helps to make more contestable. Also, the budget airline industry could

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be seen as having some degree of contestability, if firms rent planes for a few years
and then sell them. Ryanair entered the market cheaply by choosing less popular
landing slots. In recessions, however, the market is less profitable.

Sunk costs are a barrier to contestability.


They are costs which cannot be recovered one they have been spent. For example,
advertising incurs a sunk cost. A market with high sunk costs is less favourable to
enter, because the risks associated with entering the market are high.
High sunk costs are likely to push a market towards a price and output that is similar
to a monopoly.

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