A* summary on contestability

3.4.7 Contestability
Contestable market: Where there is free cost to entry or exit and has no sunk costs,
which are costs that can’t be recovered when leaving the industry
Not the no. of firms in the firm but the ease by which new firms can enter/exit


a) Characteristics of contestable markets
 Free entry or exit
 No sunk costs


b) Implications of high contestable markets for the behavior of firms (=competitive)
 Lower price – (allocative efficiency (P=MC))
 Incentive to cut costs (X-efficiency + productive efficiency(AC=MC))
 Competition incentive to innovate (dynamic efficiency)
 No SN profit (no dynamic efficiency)


c) Types of barrier to entry and exit
 EOS
 Brand loyalty
 Advertising (sunk costs)
 High initial set up costs
 Access to distributional channel
 Access to tech.
 Patent (prevent other firms from copying without patent holder’s permission)
 Whether incumbent firms vertically integrated
 Limit pricing
 Vertical integration


However, still contestable
 Niche market (e.g. Grand central compete with LNER for one network)
 Big firms come in with EOS
 Tech. advances = allow online business (esp COVID now)


d) Sunk costs and the degree of contestability
Sunk costs: costs that cannot be recovered when leaving the industry
E.g. advertising, (plane industry) planes