A Contestable Market

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    A Contestable Market

    • Instead of classifying markets according to the level of actual competition, they can also be classified according to the level of potential competition
      • A contestable market is a market in which there are no barriers to entry and exit and the costs facing incumbent and new firms are equal
    • The theory of contestable market says that what determines how firms have and how efficient they are is based on the potential amount of competition
      • A market may have a high concentration, but may still face competitive pressure
        • This could result in things like decreasing supernormal profit in the long-run.
      • Hit-and-run competition may occur in a contestable market
        • If a firm sees that supernormal profits are being made by a firm, then they will easily enter the market (due to no barriers of entry), reap the benefits of the supernormal profits, and then leave easily (due to no barriers of exit)
        • This means that markets are very responsive to changes in consumer demand.
      • A contestable market should therefore benefit consumers by being both productively and allocatively efficient
        • A firm will seek to keep costs low, and not raise prices above MC, because they’re worried about attracting new firms to the industry.
      • Obviously, in practise, a market is unlikely to be perfectly contestable, and the degree of contestability can vary over time, with a market becoming more or less contestable.

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