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CONTESTABLE MARKETS:

CONTESTABLE MARKETS:. How Economic Theory is used to influence policy. Market Structures. The Structure of a market is the manner and extent to which firms are inter-related to each other The Structure of a market refers to the degree of competition prevailing in that market

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CONTESTABLE MARKETS:

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  1. CONTESTABLE MARKETS: How Economic Theory is used to influence policy

  2. Market Structures • The Structure of a market is the manner and extent to which firms are inter-related to each other • The Structure of a market refers to the degree of competition prevailing in that market • The degree of competition is indicated through the power of a firm to influence or control price by changing its own output

  3. Factors Determining Market Structure: • No. of independent sellers (large, few, two, one) • Seller Concentration (Non-existent, low, medium, high) • Product Differentiation (Homogeneous and perfect substitutes), close substitutes, slightly differentiated, having no substitutes) • Condition of Entry (Free, Difficult but not impossible, impossible or prohibited by law)

  4. What is Contestable Market? • Market with a few firms • Free of sunk costs • Threat of new entrants • Firm(s) behave in a competitive manner (competitive pricing) • Low barriers to entry and exit • A perfectly contestable market would have no barriers to entry or exit.

  5. When do potential rivals enter? If a firm in a perfectly contestable market raises its price above marginal cost and begins to earn abnormal profits, rivals will enter the market to take advantage of these profits.

  6. When do potential rivals exit? • When the firms respond by returning to normal profits, new firms exit. • Even a single-firm market can show highly competitive behavior. • [Monopoly may not necessarily harm consumers]

  7. How to use theory to convince policy makers? An industry might be deregulated on the basis of the argument that it is naturally contestable. But if it is incorrect, it may evolve into a concentrated oligopoly • The theory of contestable markets has been used to argue for weaker application of anti trust laws in US (comparable with our MRTP act)

  8. Limitations………….. • there are very few markets which are completely free of • sunk costs • and entry and exit barriers • Performance depends on actual competition rather than potential competition

  9. Example.... • Low cost airlines are commonly referred to as an example of a contestable market. • Entrants have the possibility of leasing aircraft. • They are able to respond to high profits by quickly entering and exiting.

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