This document discusses contestable markets and provides examples of industries with varying degrees of contestability. It defines a contestable market as one where entry and exit decisions can be made without cost. Key factors that determine contestability include the absence of sunk costs, access to technology, consumer loyalty, and size of entry barriers. Various industries like movies on demand, retail coffee stores, and budget hotels are assessed as having high contestability, while industries like household mail services currently have low contestability but this may be rising. The document also examines pricing strategies in highly contestable markets and discusses concepts like hit-and-run entry and barriers to exit.

1. A2 Micro
Contestable Markets
Tutor2u, Summer 2013

2. Contestable markets
Where an entrant has access
to all production techniques
available to existing
businesses and entry
decisions can be reversed
without cost

3. 1. Knowledge of concepts and facts
2. Application of knowledge and
understanding
3. Analysis: explain economic theory
4. Evaluation: prioritise evidence and
arguments; make reasoned judgements
and recommendations; reach and
present supported conclusions
The exam tests ............

4. Build real world examples
into your notes
Common industries used
include food retailers,
energy, banks, airlines,
technology sectors

5. Key Contestability Factors
Absence of sunk costs Access to technology
Low consumer loyalty Size of entry barriers

6. Contestable Markets?
Streamed
Movies on
Demand
Retail
Coffee
Stores
Home-
Delivered
Pizza
Budget
"Value"
Hotels
City Bus and
Coach
Transport
Household
Mail Services
For each of
the industries,
choose
whether they
have Low
Contestability
(LC) or High
Contestability
(HC)

7. Movies on Demand

8. Contestable Markets?
Streamed
Movies on
Demand
Retail
Coffee
Stores
Home-
Delivered
Pizza
Budget
"Value"
Hotels
City Bus and
Coach
Transport
Household
Mail Services
For each of
the industries,
choose
whether they
have Low
Contestability
(LC) or High
Contestability
(HC)
LC
But
Rising!

10. Contestable Markets?
Streamed
Movies on
Demand
Retail
Coffee
Stores
Home-
Delivered
Pizza
Budget
"Value"
Hotels
City Bus and
Coach
Transport
Household
Mail Services
For each of
the industries,
choose
whether they
have Low
Contestability
(LC) or High
Contestability
(HC)
HC
LC
But
Rising!

11. Contestable Markets?
Streamed
Movies on
Demand
Retail
Coffee
Stores
Home-
Delivered
Pizza
Budget
"Value"
Hotels
City Bus and
Coach
Transport
Household
Mail Services
For each of
the industries,
choose
whether they
have Low
Contestability
(LC) or High
Contestability
(HC)
HC
HC
LC
But
Rising!

12. Contestable Markets?
Streamed
Movies on
Demand
Retail
Coffee
Stores
Home-
Delivered
Pizza
Budget
"Value"
Hotels
City Bus and
Coach
Transport
Household
Mail Services
For each of
the industries,
choose
whether they
have Low
Contestability
(LC) or High
Contestability
(HC)
HC
HC
HC
LC
But
Rising!

13. Contestable Markets?
Streamed
Movies on
Demand
Retail
Coffee
Stores
Home-
Delivered
Pizza
Budget
"Value"
Hotels
City Bus and
Coach
Transport
Household
Mail Services
For each of
the industries,
choose
whether they
have Low
Contestability
(LC) or High
Contestability
(HC)
HC
HC
HC
LC
LC
But
Rising!

14. Contestable Markets?
Streamed
Movies on
Demand
Retail
Coffee
Stores
Home-
Delivered
Pizza
Budget
"Value"
Hotels
City Bus and
Coach
Transport
Household
Mail Services
For each of
the industries,
choose
whether they
have Low
Contestability
(LC) or High
Contestability
(HC)
HC
HC
HC
LC
But
Rising!
LC
LC
But
Rising!

15. Great diagrams lift your
script!
Poor ones test
examiner patience
Diagrams must be big

16. Cost & Price
Output (Q)
Pricing in a Contestable Market – Some Alternatives
Cost & Price
Output (Q)
Highly Contestable Market –
Profit Maximising Output
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
AC
AR
MR
MC

17. Cost & Price
Output (Q)
Pricing in a Contestable Market – Some Alternatives
Highly Contestable Market –
Profit Maximising Output
AC
AR
MR
MC
In the left hand
diagram draw in
the profit
maximising output
and price (label it
Q1 and P1.)
Q1
P1
C1
Price > Average Cost
Supernormal profits
High profits send
signals to other
suppliers

18. Cost & Price
Output (Q)
Pricing in a Contestable Market – Possible Long Run Equilibrium?
Highly Contestable Market –
Profit Maximising Output
AC
AR
MR
MC
In the long run if
the market is highly
contestable which
level of price and
output is probable?
(Label this Q2 and
P2).
Q1
P1
C1
When AC = AR,
normal profits made,
a return sufficient to
keep factor inputs in
their present use
P2
Q2

19. Pricing in a Contestable Market – Some Alternatives
Cost & Price
Output (Q)
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
In the right hand
diagram show the
price and output
for a firm that
seeks to maximise
total revenue

20. Pricing in a Contestable Market – Some Alternatives
Cost & Price
Output (Q)
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
In the right hand
diagram show the
price and output
for a firm that
seeks to maximise
total revenue
P1
Revenue maximised
when marginal
revenue = zero

21. Pricing in a Contestable Market – Some Alternatives
Cost & Price
Output (Q)
Highly Contestable Market –
Pricing to Maximise Revenue
AC
AR
MR
MC
In the right hand
diagram show the
price and output
for a firm that
seeks to maximise
total revenue
P1
C1
Revenue maximised
when marginal
revenue = zero
Still some super
normal profits made
Lower price and
higher output than
MC=MR
Revenue max means
a lower profit margin
is made – usually
good for consumer
welfare – but profit
has value too!

22. Hit and Run Entry
Entry to a market in hope of an immediate profit
Absence of sunk costs makes this easier!

23. Strong brands can make it easier to enter a new market!

24. Examples of Exit Barriers
Asset write-offs Lost consumer goodwill Redundancy costs
Costs
Exit costs can be an
important barrier to
contestability in
markets – many
students ignore them!

25. Get help from fellow
students, teachers and
tutor2u on Twitter:
@tutor2u_econ