Theory+of+Contestable+Markets

= The Theory of Contestable Markets  =

** Introduction: ** Behavior of firm is not determined by degree of competition in market, but degree of **potential** competition.

** Definition: ** A contestable market is one in which there is freedom of entry to the industry and costs of exit are low.  Economists have observed structures with few firms, which have low barriers to entry and it is argued that monopolies and oligopolies where there are low barriers to entry may behave not like traditional theory suggests, but that they may behave more like a perfectly competitive industry.

** Key Assumptions Linked to Contestable Markets **  ||  Firms only make normal profits in the long run. Additionally, they probably only make normal profits in the short run because abnormal profits would attract competitors. ||  ||  Firms behave in the same way as they do in any other market structure. ||  “The theory of contestable markets has been used to argue for weaker application of [|antitrust laws], as simply observing a monopoly market may not prove that a firm is exploiting its [|market power] to control the price level. The applicability of the theory to real world situations has been questioned, however, particularly as there are very few markets which are completely free of [|sunk costs] and entry and exit barriers.  Low-cost airlines remain a commonly-referenced example of a contestable market; entrants have the possibility of leasing aircraft and should be able to respond to high profits by quickly entering and exiting. In practice, however, there may be entry/exit barriers in the form of terminal leases and availability.” Source Wikipedia: []
 *  No.  ||  Assumption   ||  Consequence   ||
 *  ||   || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;">  ||
 * <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> 1.  || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> There is freedom of entry to and exit from the market.
 * <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> 2.  || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> There is price competition and no collusion over prices.   || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> This drives profits towards normal levels. This will also result in firms being productively and allocatively efficient.   ||
 * <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> 3.  || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> The number of firms may vary from one to many.   || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> Perfect and monopolistic competition structures are contestable but monopoly, duopoly and oligopoly structures can also be contestable when the sunk costs of leaving an industry are relatively low.   ||
 * <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> 4.  || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> Goods may be homogenous or branded.   || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> Perfect competition or a concentrated structure.   ||
 * <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> 5.  || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> All participants in the market have perfect knowledge.   || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> Everyone knows what’s going on.   ||
 * <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> 6.  || <span style="line-height: 19.0pt; margin-bottom: .0001pt; margin-bottom: 0cm; mso-layout-grid-align: none; mso-pagination: none; text-autospace: none;"> Firms produce where MC = MR.