Recap What are sunk costs What are barriers to entry Can you name 3 industries where you think it would be virtually impossible for a new firm to enter AQA 15 Perfect Competition Imperfectly Competitive Markets and Monopoly ID: 533092
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Slide1
1.5.9 Contestable and non-contestable markets
RecapWhat are sunk costs?What are barriers to entry?Can you name 3 industries where you think it would be virtually impossible for a new firm to enter?
AQA 1.5: Perfect Competition, Imperfectly Competitive Markets and MonopolySlide2
1.5.9 What you need to know
The significance of market contestability for the performance of an industryConcepts such as sunk costs and hit-and-run competitionSlide3
Contestable markets
A contestable market is a type of market structure that is competitive because of a lack of barriers to entry. A perfectly contestable market exhibits the following characteristics:Freedom to enter or exit the marketNo sunk costs Perfect knowledge
Price cannot be set above average cost as supernormal profits will attract hit and run competition to enter the marketIn reality we look at the degree of contestability in the market as perfectly contestable markets do not existA
sunk cost
is one that the firm
cannot
recover if it were to exit the market
.
Freedom to enter or exit the market
means that factors of production are perfectly mobile so no barriers to entry exist.
Perfect knowledge
occurs when
all
producers and consumers
in a market are fully aware of price, quantity available and other relevant information for all products when making buying decisions
.
Hit and run competition
occurs when firms enter the market to take advantage of short term supernormal profits.Slide4
Contestable markets
and perfect competitionContestable markets differ to those in perfect competition as firms can: Sell both homogenous (identical) or heterogeneous (different)
productsDisplay elements of monopoly power e.g. by being a price leader in the marketBe small in number e.g. the market might be oligopolisticThe significance of contestable markets is that firms can easily enter or exit the market to access supernormal profits
This threat of potential entrants means that
incumbent
firms only make normal profits
An
incumbent
firm is one that already exists in the market.Slide5
Freedom to enter or exit
the marketFreedom to enter or exit the market means that factors of production are perfectly mobile so no barriers to entry or exit existThis means that all firms have access to the same technology
The average costs of all firms are likely to be the same for both new entrants and existing firms as firms are unable to exploit economies of scaleIf firms in the market raise price and earn supernormal profits new entrants will take advantage and move into the marketIf the original firms lower price and supernormal profits no longer exist the hit and run competition will leave the marketAs there is free entry and exit the hit and run competitor does not have any substantial costs e.g. their machines can still be put to use for other purposesThis guarantees only
normal profit
in the long run
Firms might use
limit pricing
, deliberately keeping price low to deter new entrants into the market.
This leads to
normal profits
being made in the industry.Slide6
Sunk costs
Sunk costs are costs that the firm cannot recover if it were to exit the marketAs these costs are irretrievable they will impede the free exit of firms from the industrySunk costs should not be taken into account when making future investment decisions However, a firm will be aware that sunk costs will exist in a marketThis will deter hit and run entrants into a market Therefore, the market is less likely to be contestable Slide7
Perfect knowledge
Perfect knowledge occurs when all producers and consumers in a market are fully aware of price, quantity available and other relevant information for all products when making buying and production decisionsThis means that all firms have access to the same technology and can use it at the same costIf a firm has a competitive advantage due to better technology this will lower its average costs and impede the entry of new firms into the marketTherefore, the market is less likely to be contestable Slide8
Market contestability and the performance
of an industryContestability will impact on efficiency in a market:Productive efficiency will exist as firms operate at the lowest point on their average cost curve. If they didn’t new firms would enter the market with lower AC and could charge a lower price
Allocative efficiency occurs as firms: only make normal profits (AR or P = AC)operate at the lowest cost output (MC = AC)Thus, P = MC the criterion for allocative efficiency
Dynamic efficiency
might occur as firms innovate production processes in order to lower
AC. This is made easier as firms have greater access to industry wide technologySlide9
Contestable
markets v monopoly
Price
Output
AR = D
MR
MC
AC
Q
P
Contestable markets v monopoly
In
monopoly
firms can make supernormal profits in the short run where AR is greater than AC. Price is set at P. In the long run there are
barriers to entry
stopping new firms entering the industry. Therefore, the firm makes supernormal profits (the shaded box) in both the short run and the long run.
In
contestable markets
the threat of new firms entering the industry stops this from happening. To stop these firms entering the market the monopolist sets price at P1
where AR = AC with an increased output of Q1. It will operate where MC = AC on the lowest point of the AC curve.
P
1
Q
1Slide10
Market contestability
and government policyGovernment policy looks to make markets more contestableThe ability of a firm to raise P above AC depends upon contestabilityBy reducing the cost of entry into a market contestability increases and firms will have less ability to raise priceTherefore, the threat of new entrants stops firms in concentrated markets from abusing market powerThe government is not trying to increase the number of firms in the market but to make them more competitiveSlide11
Market contestability
and government policyThe government use competition policy in order to make markets more contestableRegulation – using competition law to stop firms abusing market power e.g. predatory pricing and cartelsDeregulation - making it easier for new firms to enter and exit the market by liberalising markets and lowering barriers to entry
Creating a shared technology environment – making it easier for firms to access the latest technology and information cheaply and convenientlySlide12
Contestable v non-contestable
Work in pairs to summarise the key characteristics of contestable and non-contestable marketsContestableNon-contestable
Can supermarkets steal more of big banking's business
?
To what extent is the banking market contestable?Slide13
Activity
To what extent do you consider the smartphone market to be contestable?
Justify your answer with reference
to these
articles
and your own
research.