A contestable market has few competitors but a high threat of entry, ensuring competitiveness and avoiding monopoly. Criteria for a high threat of entry include low sunk costs, equal access to technology, and free access to customers. In a contestable market, prices can be set by producers, and size is irrelevant. However, profitability can lead to an oligopoly.
In economics, a contestable market is a business theory in which a market has few competitors but has a high threat of entry. As a result, companies tend to be competitive. This avoids the monopoly in the market and ensures that the products have competitive prices and quality.
For a market to have a high threat of entry, several criteria must be met. First, new suppliers must be able to come and go without too much cost. The sunk cost of establishing a new business should be minimal. Sunk costs are the sunk expenses incurred in entering the 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 must be available to all competitors. No producer should have technological superiority. This is practically impossible to see in reality, as companies often try to keep whatever competitive advantages they have.
Finally, new suppliers must be allowed to market to customers. They should have free access to the established company’s customers and advertise to them at no cost. This discourages the occurrence of a coercive monopoly.
A contestable market is characterized by its susceptibility to entry and exit. When a market becomes profitable for the incumbent, new suppliers suddenly enter it to gain a share of the profits. Once the market is sold out, vendors leave at virtually no cost.
There are fundamental differences between contestable markets and perfect competition. In a contested market, a producer can set prices, whereas in perfect competition, prices are dictated by competitors. The size of a company is irrelevant in a contested market. On the other hand, the size of firms in perfect competition will be relatively uniform. Furthermore, a contestable market may consist of only one producer, while perfect competition must have several competitors.
One of the reasons contestable markets are difficult to put into practice is their profitability. An established company can set the price for a product, but new producers can exploit it. Since the technology and the market are accessible to everyone, a new producer can easily conquer the market by selling the same products at a slightly lower price. A single producer will always feel threatened and act as if there are always multiple competitors in the field. On the other hand, as the companies receive the same income and incur the same expenses, they may decide to increase their profit margins by forming an oligopoly.
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