• A?contestable market?occurs when there is?freedom of entry?into a market & where?costs of exit are low
  • A contestable market & competition are different
    • Competition?is based upon the number of?firms competing in a market
    • A?contestable market?is based upon the?threat of new entrants
• Contestable markets are characterised by

1. No barriers to entry or exit:?barriers to entry are low or non-existent & there are no?sunk costs. This allows firms to easily join or leave the market
2. No competitive disadvantages on entry: new firms are able to setup & immediately compete with existing firms & have access to the?same technology
3. Perfect information:?There is no proprietary knowledge that would limit competition?(e.g. patents)
4. Hit & run competition:?Short-run?supernormal profit?acts as a profit signaling mechanism & new firms easily enter the market,?extract profit, then leave

• The more contestable a market, the more the?behaviour?of existing competitors may be?modified
  • E.g. Firms making?supernormal profit?may change their pricing strategy from?profit maximisation (MC=MR)?to?limit pricing
  • They are even likely to set the?price = average cost?(AR=AC)
    • This will reduce?hit & run competition
    • It will result in?normal profit
    • There will be less disruption to the market
• The more contestable a market, the more the behaviour of firms?resembles that of firms in?perfect competition

• Barriers to entry?are conditions that make it difficult or expensive for a firm to enter a market in order to compete with the existing suppliers
• Barriers to exit?are factors that either?prevent a firm from leaving a market, or make it difficult to leave even if they are making a loss

Types of Barriers to Entry

Sunk Costs & the Degree of Contestability

• One of the main barriers to exit is the existence of?sunk costs
  • E.g. To enter the industry, the firm may have?acquired expensive assets?that are highly specialised & difficult to resell
  • Other examples include money spent on advertising, research & development, branding etc.
• If sunk costs in an industry are high, it will?limit competition & decrease?contestability?as firms will be more hesitant to enter
  • The lower the sunk costs the?more contestable?the market
  • The higher the sunk costs the?less contestable?the market