Essay: Contestable Markets

A contestable market occurs when there is freedom of entry and exit into the market. Thus there will be low levels of sunk costs. When considering the contestability of markets it is important to consider the following points.

 

  1. Sunk Costs. 

If Sunk costs are high this makes it difficult for new firms to enter and leave the market. Therefore it will be less contestable. 

  1. Levels of Advertising and brand loyalty.  

If an established firm has significant brand loyalty such as Coca Cola, then it will be difficult for a new firm to enter the market. This is because they would have to spend a lot of money on advertising which is a sunk cost. 

  1. The level of Profit 

If a firm is making very high profit, this is an indication that the market is not contestable, because hit and run competition should enable new firms to enter and reduce the profitability 

  1. Vertical Integration 

If a firm does not have access to the supply of a good then the market will not be contestable. E.g. Oil firms could restrict the supply of petrol to petrol stations, making it difficult for new firms to enter. E.g. for airlines a big issue is whether you can get a landing slot at a big airport. 

  1. Access to technology and skilled labour 

For some industries like car production it is difficult for new firms to have the right technology. Nuclear power may require skilled labour that is difficult to get. 

 

Conclusion

It is important to remember that contestability is not a clear cut issue, there are degrees of contestability, some markets having more capacity for new firms to enter.

Example UK Banking industry

1. There are high sunk costs in getting a network of banks set up around the country..

2. Brand loyalty to existing banks is high. Customers are unwilling to switch. Therefore a new firm would have to spend alot on advertising, which is a sunk cost, therfore not contestable.

3. Existing banks make very high profits, suggesting hit and run competition does not occur.

These issues suggest banking is not contestable.

However the introduction of the internet has reduced set up costs and enabled new firms to enter the market for online banking e.g. EGG.

Therefore the banking industry has become more contestable in recent years, although the big 5 banks still dominate on the high street.

 

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