A contestable market has few competitors but a high threat of entry, promoting competition and preventing monopolies. Criteria for a strong entry threat include minimal sunk costs, equal access to technology, and free access to customers. Prices can be set by manufacturers, and the size of firms is irrelevant. Profitability and the potential for oligopolies are challenges.
In economics, a contestable market is a business theory in which a market has few competitors but a high threat of entry. As a result, companies tend to be competitive. This prevents market monopoly and ensures that products have competitive prices and quality.
For a market to have a strong entry threat, several criteria must be met. First, new suppliers must be able to enter and exit without excessive costs. The sunk cost of setting up a new business should be minimal. Sunk costs are the sunk expenses incurred when entering a market. In a perfectly contestable market, entry and exit would be free.
Second, all the information and technology needed to produce goods of the same quality should be available to all competitors. No manufacturer should have technological superiority. This is virtually impossible to see in reality, as companies generally try to maintain any competitive advantage they have.
Finally, you need to allow new vendors to market to customers. They must have free access to the clients of the incumbent company and advertise to them for free. This discourages coercive monopoly from occurring.
A contestable market is characterized by its susceptibility to hitting and rushing entry. When a market becomes profitable for the incumbent firm, new suppliers suddenly enter it to gain profit share. After the market is depleted, suppliers then depart at virtually no cost.
There are fundamental differences between contestable markets and perfect competition. In a contested market, a manufacturer can set prices, whereas in perfect competition, prices are dictated by competitors. The size of a firm is irrelevant in a contestable market. On the other hand, the size of firms in perfect competition will be relatively uniform. Furthermore, a contestable market can consist of only one manufacturer, whereas perfectly competitive market must have several competitors.
One reason contending markets are difficult to put into practice is their profitability. An incumbent firm can fix the price of a product, but new producers can exploit it. Since the technology and the market are accessible to everyone, a new manufacturer can easily capture the market by selling the same products at a slightly lower price. A single manufacturer will always feel threatened and act as if there are always several competitors in the field. Conversely, since firms receive the same revenues and incur the same expenses, they may decide to increase their profit margins by forming an oligopoly.
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