Edexcel A Level Economics A:复习笔记3.4.7 Contestability

Characteristics of Contestable Markets

  • A contestable market occurs when there is freedom of entry into a market & where costs of exit are low
    • A contestable market & competition are different
      • Competition is based upon the number of firms competing in a market
      • A contestable market is based upon the threat of new entrants
  • Contestable markets are characterised by
  1. No barriers to entry or exit: barriers to entry are low or non-existent & there are no sunk costs. This allows firms to easily join or leave the market
  2. No competitive disadvantages on entry: new firms are able to setup & immediately compete with existing firms & have access to the same technology
  3. Perfect information: There is no proprietary knowledge that would limit competition (e.g. patents)
  4. Hit & run competition: Short-run supernormal profit acts as a profit signaling mechanism & new firms easily enter the market, extract profit, then leave

Implications of Contestable Markets for Firms

  • The more contestable a market, the more the behaviour of existing competitors may be modified
    • E.g. Firms making supernormal profit may change their pricing strategy from profit maximisation (MC=MR) to limit pricing
    • They are even likely to set the price = average cost (AR=AC)
      • This will reduce hit & run competition
      • It will result in normal profit
      • There will be less disruption to the market
  • The more contestable a market, the more the behaviour of firms resembles that of firms in perfect competition

Types of Barriers to Entry and Exit

  • Barriers to entry are conditions that make it difficult or expensive for a firm to enter a market in order to compete with the existing suppliers
  • Barriers to exit are factors that either prevent a firm from leaving a market, or make it difficult to leave even if they are making a loss

Types of Barriers to Entry

Economies of scale Legal barriers
Occurs when an increase in the scale of output results in a lower cost per unit e.g purchasing economies
(see sub-topic 3.3.3)
 

Patents, copyright & government licenses prevent competitors from entering the market e.g. 5G licenses in the mobile industry

Ownership of essential resources Anti-competitive practices by competitors
If existing competitors' own resources that are essential to the production of a product, entry into the industry will be limited e.g cobalt is essential when manufacturing electric batteries and in 2021, Glencore controlled 22% of the world's supply These include predatory pricinglimit pricing & aggressive takeover activity in order to limit the amount of competition

Sunk Costs & the Degree of Contestability

  • One of the main barriers to exit is the existence of sunk costs
    • E.g. To enter the industry, the firm may have acquired expensive assets that are highly specialised & difficult to resell
    • Other examples include money spent on advertising, research & development, branding etc.
  • If sunk costs in an industry are high, it will limit competition & decrease contestability as firms will be more hesitant to enter
    • The lower the sunk costs the more contestable the market
    • The higher the sunk costs the less contestable the market

 

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