Contestable markets - Chapter 6
- Created by: sammilaw
- Created on: 06-01-16 17:07
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- Contestable markets
- Chapter 6
- Theory: absence of barriers to entry and level of sunk costs is more important than number of firms in the market
- Assumptions:
- Freedom to entry and exit
- Low level/no sunk costs
- Threat of 'hit and run entry' from new firms
- When new firms enter the market to cream off some of the supernormal profits of the incumbents
- No one firm has significant share of the market
- Firms are SR profit maximisers - produce at MC=MR
- Firms compete so there is no collusion
- Firms may produce homogeneous or heterogeneous goods
- There is perfect knowledge in the market
- 'Hit and Run entry'
- Forces firms to operate as they would in a perfectly competitive industry at LR equilibrium
- as new firms can take some of the profits by entering the market, offering the same good at a lower price
- forces incumbent firms to lower their price (and increase output)
- new firm leaves the market, suffering little from low or no sunk costs
- forces incumbent firms to lower their price (and increase output)
- as new firms can take some of the profits by entering the market, offering the same good at a lower price
- Example: bus companies (new firms opening new routes or lowering prices)
- Forces firms to operate as they would in a perfectly competitive industry at LR equilibrium
- Main approaches:
- De-regulation: i.e. reducing statutory barriers to entry (examples: telecommunications and postal services)
- Tougher competition laws acting against predatory behaviour by incumbent firms
- and tougher rules against cartels
- Evaluation
- There are NO perfectly contestable markets
- The threat of entry of new firms may not be enough to affect the behaviour of incumbents
- Contestability may force existing firms away from profit maximising and towards sales max etc.
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