Contestable markets and hit-and-run competition

Overview

Recall questions on what makes a market contestable, hit-and-run entry, limit pricing, and how the threat of entry disciplines an incumbent.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What defines a contestable market?

   Model answer

   A market where there is freedom of entry and exit, meaning potential competitors can enter and leave without significant barriers.

2. 2

   What level of sunk costs characterises a perfectly contestable market?

   Model answer

   Zero sunk costs, allowing firms to enter and exit without losing irrecoverable expenditure.

3. 3

   What is hit-and-run competition?

   Model answer

   When firms enter a market to exploit short-term profits and exit before incumbent firms can respond.

4. 4

   Why does the threat of hit-and-run competition discipline incumbent firms?

   Model answer

   Because potential entrants can quickly capture supernormal profits and leave, forcing incumbents to keep prices competitive to deter entry.

5. 5

   Why can incumbent firms not sustain supernormal profits in the long run in contestable markets?

   Model answer

   Because the threat of entry forces them to behave competitively, eliminating supernormal profits.

6. 6

   What is limit pricing?

   Model answer

   Setting prices low enough to deter potential entrants while still covering costs.

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