What is a contestable market?

A market with freedom of entry and exit and low or zero sunk costs, where the threat of potential competition constrains the behaviour of incumbent firms.

Costs that cannot be recovered if a firm exits the market, such as advertising expenditure or specialised equipment with no resale value.

Why do high sunk costs reduce market contestability?

They act as a barrier to entry and exit because potential entrants face greater risk of loss if they fail, deterring them from entering the market.

Why are sunk costs, rather than fixed costs in general, the key barrier in contestability theory?

Fixed costs spent on assets that can be resold are recovered on exit, so they need not deter entry, whereas sunk costs are lost on exit and make entry risky.

How does the threat of hit-and-run entry affect incumbent firms' pricing behaviour?

It disciplines incumbents to keep prices close to average cost, even if they currently hold market power, to avoid attracting new entrants.

AQA A-Level Economics 7136

Economic Methodology and the Economic Problem

Topic overview Economics as a social science, and positive and normative statements The economic problem, factors of production and opportunity cost Production possibility diagrams

Individual Economic Decision Making

Topic overview Consumer behaviour and utility Imperfect information Aspects of behavioural economic theory Behavioural economics and economic policy

Price Determination in a Competitive Market

Topic overview Demand, the demand curve, income and wealth Substitutes, complements and consumer preferences Price elasticity of demand and total revenue The determinants of price elasticity of demand Income and cross elasticity of demand The determinants of supply Price elasticity of supply Equilibrium, disequilibrium and how a market clears Shifts in demand and supply, and the price mechanism The interrelationship between markets

Production, Costs and Revenue

Topic overview Production, productivity and specialisation Costs of production in the short and long run Economies and diseconomies of scale Revenue and profit The law of diminishing returns and returns to scale Technological change

Perfect Competition, Imperfectly Competitive Markets and Monopoly

Topic overview The characteristics of the four market structures Price takers, price makers and non-price competition Competitive markets The objectives of firms Profit maximisation and the divorce of ownership from control Profit maximisation and the shutdown condition Price taking, entry and exit, and long-run equilibrium Efficiency in perfect competition and its assumptions Monopolistic competition in the short run Monopolistic competition in the long run The characteristics of oligopoly and barriers to entry The kinked demand curve and price rigidity Collusion, cartels and price leadership Non-price competition in oligopoly The advantages and disadvantages of oligopoly Monopoly power and barriers to entry The monopoly diagram and supernormal profit The costs and benefits of monopoly Price discrimination The dynamics of competition Creative destruction and the competitive market process Contestable and non-contestable markets Static and dynamic efficiency Market structure and resource allocation Consumer and producer surplus

The Labour Market

Topic overview The demand for labour and marginal productivity theory The supply of labour Wage determination in competitive labour markets Wage determination in imperfectly competitive labour markets Trade unions and wage determination The National Minimum Wage Discrimination in the labour market

The Distribution of Income and Wealth: Poverty and Inequality

Topic overview Income, wealth and the causes of their distribution Equality, equity, the Lorenz curve and the Gini coefficient The arguments about inequality The problem of poverty Progressive taxation and transfer payments Means-tested benefits, universal benefits and the poverty trap Wealth taxes and state provision Evaluating redistribution

The Market Mechanism, Market Failure and Government Intervention

Topic overview How markets and prices allocate resources The meaning of market failure Public goods, private goods and quasi-public goods Positive and negative externalities Merit and demerit goods Market imperfections An inequitable distribution of income and wealth Indirect taxes and subsidies Price controls, state provision and regulation Pollution permits and the extension of property rights Evaluating intervention and the mixed economy Government failure Competition policy Public ownership, privatisation, regulation and deregulation

The Measurement of Macroeconomic Performance

Topic overview The objectives of government economic policy Macroeconomic indicators and index numbers Uses of national income data

How the Macroeconomy Works

Topic overview The circular flow of income The aggregate demand and aggregate supply curves What shifts short-run and long-run aggregate supply Macroeconomic equilibrium and economic shocks Consumption and investment Government spending and net exports The accelerator, saving and investment Aggregate demand and the level of economic activity The determinants of aggregate supply

Economic Performance

Topic overview Short-run and long-run economic growth The economic cycle and output gaps Demand-side and supply-side shocks Measuring unemployment and the types of unemployment The determinants of employment and policies to reduce unemployment Inflation and deflation The quantity theory of money Consequences of inflation and deflation The balance of payments on current account Output gaps and the growth-inflation conflict Reconciling policy objectives in the AD/AS model

Financial Markets and Monetary Policy

Topic overview The characteristics and functions of money Financial markets and their role Debt, equity and bond yields Commercial banks, investment banks and the balance sheet Liquidity, profitability, security and credit creation The instruments and institutions of monetary policy How bank rate changes affect the economy What the MPC considers, and the exchange rate channel The functions of a central bank The bank rate and the MPC's decisions Exchange rate movements and the macroeconomy The monetary policy transmission mechanism Quantitative easing and unconventional policy The regulators and the risks banks face Liquidity ratios, capital ratios and systemic risk

Fiscal Policy and Supply-Side Policies

Topic overview Fiscal policy and aggregate demand Types of tax The budget balance and the national debt The purposes of public expenditure and taxation The principles of taxation Budget deficits, surpluses and their effects The national debt and fiscal rules Supply-side policies and how they work Market-based and interventionist supply-side policies

The International Economy

Topic overview The causes and characteristics of globalisation The impact of globalisation on developed and developing economies Multinational corporations Comparative and absolute advantage The effects of trade and changing trade patterns Tariffs, quotas and the tariff diagram Arguments for and against protectionism Trading blocs and the World Trade Organisation The components of the balance of payments Causes of current account imbalances and investment flows Correcting imbalances and their consequences How exchange rates are determined in a floating system Government intervention and fixed exchange rates Floating rates and currency unions Growth, development and less-developed economies Measuring development: the HDI and other indicators Investment and education as drivers of development Corruption, governance and institutional barriers Infrastructure, human capital and property rights Market-based and interventionist development strategies Aid and trade as development strategies Growth, globalisation and inequality

Perfect Competition, Imperfectly Competitive Markets and Monopoly

Contestable and non-contestable markets

3 things to know
Papers 1 and 3

Overview

Sunk costs, hit-and-run entry, and why the threat of entry can discipline an incumbent.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Numbers

What reduces contestability, and what does contestability theory say matters most?

Process

What is hit-and-run competition, and what profit can a monopolist earn in a contestable market?

Key term

Why does incumbent control of essential resources reduce market contestability?

Questions from this subtopic

Each one with the model answer underneath.

1
What is a contestable market?
Model answer
A market with freedom of entry and exit and low or zero sunk costs, where the threat of potential competition constrains the behaviour of incumbent firms.
2
Define sunk costs.
Model answer
Costs that cannot be recovered if a firm exits the market, such as advertising expenditure or specialised equipment with no resale value.
3
Why do high sunk costs reduce market contestability?
Model answer
They act as a barrier to entry and exit because potential entrants face greater risk of loss if they fail, deterring them from entering the market.
4
Why are sunk costs, rather than fixed costs in general, the key barrier in contestability theory?
Model answer
Fixed costs spent on assets that can be resold are recovered on exit, so they need not deter entry, whereas sunk costs are lost on exit and make entry risky.
5
What is hit-and-run competition?
Model answer
When firms enter a market to exploit short-term supernormal profits and then exit before incumbents can respond, which is only possible when sunk costs are low.
6
How does the threat of hit-and-run entry affect incumbent firms' pricing behaviour?
Model answer
It disciplines incumbents to keep prices close to average cost, even if they currently hold market power, to avoid attracting new entrants.

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Production, Costs and Revenue

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