Contestable markets - Chapter 6

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  • 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
      • Example: bus companies (new firms opening new routes or lowering prices)
    • 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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