Contestability and Perfectly Contestable Markets

The video explores the concept of contestable markets, focusing on the role of barriers to entry and exit, and the impact of sunk costs and technology access. It distinguishes between perfect contestability and perfect competition, highlighting that perfectly contestable markets may not have many firms. The video explains hit and run competition, where new entrants exploit supernormal profits, and discusses how incumbents can prevent this by maintaining normal profits. The importance of market contestability is evaluated, emphasizing that the threat of competition can influence pricing strategies.

What primarily determines the contestability of a market?

• The barriers to entry and exit

• The pricing strategies of incumbents

• The level of technology used

• The number of firms in the market

How does a perfectly contestable market differ from a perfectly competitive market?

• It has no barriers to entry or exit

• It requires many firms to operate

• It can have a small number of firms

• It always results in monopoly power

What is a potential outcome of monopoly power in a contestable market?

• Firms can charge any price they want

• Supernormal profits attract new entrants

• Incumbents are protected from competition

• Market prices remain stable

What is the primary strategy incumbents use to prevent hit and run competition?

• Reducing market share

• Increasing barriers to entry

• Charging at average cost

• Increasing production costs

Why might the threat of hit and run competition be significant in a contestable market?

• It reduces the number of firms in the market

• It compels incumbents to charge average costs

• It ensures supernormal profits

• It forces incumbents to innovate