Contestable Markets

A2 Markets & Market Systems Contestable Markets | | affect the behaviour of businesses in the market-place.What is a contestable market?William Baumol defined contestable markets as existing where “an entrant has access to all production techniques available to the incumbents, is not prohibited from wooing the incumbent’s customers, and entry decisions can be reversed without cost.” For a contestable market to exist there must be low barriers to entry and exit so that there is always the potential for new suppliers to come into a market to provide fresh competition to existing suppliers. For a perfectly contestable market, entry into and exit out of the market must be costlessThe reality is that no market is perfectly contestable (there are always some “barriers to contestability” – see your revision notes on barriers to entry). That said it is also true that virtually every market is contestable to some degree even when it appears that the monopoly position of a dominant seller is unassailable. This can have important implications for the competitive behaviour (conduct) of existing firms and clearly then affects the performance of a market from an economic efficiency viewpoint (e.g. allocative, productive and dynamic efficiency)Contestable markets and perfect competition - the differencesContestable markets are different from perfect competitive markets. For example, it is feasible in a contestable market for one firm to dominate the industry, have price-setting power and also for firms in a market to produce a differentiated product both of which run counter to the assumptions behind the traditional model of perfect competition. There are three main conditions for pure market contestability: 1. Perfect information and the ability and/or the right of all suppliers to make use of the best available production technology in the market 2. The freedom to market / advertise and enter a market with a competing product 3. The absence of sunk costs – this