Definition of Market Contestability – Contestability means that a market has freedom of entry and exit. In other words new firms can enter and leave easily; this creates a permanent threat of competition. Contestability requires low sunk costs (costs that are non recoverable). If an industry has high sunk costs, it creates a cost to leave and deters entry.

How The Internet has Helped Increased Contestability

• Provided a New Entry point for many market. For example some new banks have been able to offer online banking services (such as egg and direct line). This has made the market more contestable because new firms have been able to enter an industry with traditionally high barriers to entry.
• Reduced Costs of entering a market. To set up a network of branches is a high fixed cost and therefore is a barrier to entry. The internet has enabled firms to compete with lower set up costs. Generally, the costs of running an online industry is lower than buying lots of high street retail shops.
• More information. The internet has helped increase availability of information such as low prices. This gives new firms a better chance because the internet helps them to become established. Without the internet established firms often use their brand loyalty to keep prices high and deter new firms entering.
• Internet also enables firms to have better information about technology and cheapest suppliers reducing advantage of established firms

Evaluation

• Works better for some industries than others. E.g. Clothing retail doesn’t do well on the internet because people like to visit the shops. The market for air tickets however has become more competitive because price is the most important factor
• Internet creates its own barriers of entry. For example, it is difficult to get high google rankings unless you are established and have a lot of resources to promote your website.
• People may not trust new online businesses. The internet has a reputation for ’shady practicies’

See also: Are Monopolies always bad?

• Barriers to entry

An appreciation in the exchange rate would tend to reduce aggregate Demand and lead to lower economic growth. An appreciation makes exports less competitive, decreasing quantity of exports. An appreciation also  makes imports cheaper, increasing quantity of imports (and hence money leaving the economy). Therefore, the (X-M) component of AD will be lower. This will reduce Economic growth.

AD/AS Diagram showing effect of appreciation

However, an appreciation doesn’t necessarily lead to slower growth. If UK house prices have been rising, then there will have been a positive wealth effect leading to higher consumer spending. Also, if demand for exports is inelastic, an appreciation will not reduce the value of exports. Therefore, the strong growth in the UK may not be due to supply side policies but because AD continues to rise due to various other factors.

Supply side policies can help to increase growth. For example, recently, the government have attempted to improve education and training (new deal and other policies); this should increase labour productivity and shift AS to the right. Although, these take a long time they will help to increase the economic growth rate in an economy.

Diagram showing effect of Successful Supply Side Policies

Another supply side policy could be privatisation. This has helped increase the efficiency of privatised firms and boost productivity in the economy. This shift in AS helps to increase growth. It is also possible that successful supply side policies can increase confidence and investment in the economy and therefore, help boost AD as well as AS.

But, mainly supply side policies help to increase the long run trend rate of growth rather than deal with temporary demand side shocks. Supply side policies can help increase the long run trend rate, but, don’t necessarily increase AD.

Growth has been maintained in the UK because AD continues to rise as well as rising AS. This reflects the strength of consumer spending and perhaps expansionary fiscal policy.

To get full marks you would also need to make reference to the data and give precise figures.

This is definitely the more difficult part of the exam. I think most A2 students will find some of these ideas harder to think of in an exam. Some evaluation ideas could include

1. Lower economic Growth.

Lower competitiveness makes exports less attractive, therefore there will be a fall in exports causing lower economic growth.

However.

1. Economic Growth could still occur due to strong consumer demand. The UK’s manufacturing export sector has been decreasing in importance; now, it only contributes a relatively small % to the UK’s growth. In recent years, it has been consumer spending which has kept growth high (despite an increasing current account deficit)
2. Does the fall in competitiveness extend to all sectors of the economy? Maybe the UK is losing competitivenes in manufacturing exports, but retains a competitive advantage in financial sector. Therefore, there is still room for growth from these other sectors.
3. The fall in growth will effect some sectors and regions of the economy more than others.

Current Account Deficit

Lower competitiveness is likely to cause lower exports, higher imports and an increase in the current account deficit.

However.

1. Does a current account deficit matter these days? It is argued that due to globalisation capital flows are easy to attract. Therefore, a current account deficit is not a problem because the UK can attract sufficient short term and long term capital investment. (note this view on the current account is not shared by all economists.
2. A fall in competitiveness will lead to a depreciation in the exchange rate. Therefore, the UK should retain its competitiveness through exchange rate changes. Therefore, although the current account deficit may get worse in the short term. In the long term the devaluation in the pound will help the current account deficit to get smaller again.
3. Depends on elasticity of demand. If demand for UK exports is inelastic then a decline in competitiveness will only have a small fall in demand. If demand is elastic it will be much more serious. (Elasticity is always a good tool for evaluation purposes)

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