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Contestability

How contestability can cause monopolies to charge a competitive price

Date : 24/01/2023

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Nasim

Uploaded by : Nasim
Uploaded on : 24/01/2023
Subject : Economics

Contestability refers to the ability of potential competitors to enter and exit a market easily. A market is considered contestable if entry barriers are low and exit barriers are high. In a contestable market, existing firms are forced to compete on price and quality, leading to efficient outcomes for consumers.

From a classical economic theory perspective, a perfectly competitive market is considered the ideal market structure. In a perfectly competitive market, there are many firms, each producing a homogeneous product and there are no barriers to entry or exit. This leads to a situation where firms must charge a competitive price and produce at the lowest cost possible in order to survive.

However, in reality, most markets are not perfectly competitive and may have one or more firms with a significant market share. This is known as a monopolistic market structure, where one firm has significant market power. In a monopolistic market, the monopolist firm has the ability to charge a higher price and produce at a lower level than would be the case in a perfectly competitive market.

The concept of contestability can be used to analyse the behaviour of monopolies. A market is considered contestable if it is easy for new firms to enter and existing firms to exit. In a contestable market, even a monopolist firm is forced to act as if it were in a perfectly competitive market, charging a competitive price and producing at the lowest cost possible. This is because the threat of potential competition is enough to keep the monopolist in check.

In contrast, a market is considered non-contestable if entry barriers are high and exit barriers are low. In a non-contestable market, a monopolist firm has the ability to charge a higher price and produce at a lower level without the threat of potential competition.

In conclusion, contestability is an important concept in the analysis of monopoly behavior from a classical economic theory perspective. A market that is contestable forces firms to act as if they were in a perfectly competitive market, leading to efficient outcomes for consumers. On the other hand, a non-contestable market allows firms to exercise market power and charge higher prices.

This resource was uploaded by: Nasim