tutor2u™ Supporting Teachers: Inspiring Students Economics Revision Focus: 2004 A2 Economics Contestable Markets
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Revision Focus on Contestable Markets
A2 Syllabus Requirements: Candidates should be able to discuss the significance of market contestability for the performance of an industry. They should be familiar with concepts, such as sunk costs and hit and run competition. What is a contestable market? Baumol defined contestable markets as existing where “an entrant has access to all production techniques available to the incumbents, is not prohibited from wooing the incumbent’s customers, and entry decisions can be reversed without cost.”
For a contestable market to exist there must be low barriers to entry and exit so that there is always the potential for new suppliers to come into a market to provide fresh competition to existing suppliers. For a perfectly contestable market, entry into and exit out of the market must be costless
The reality is that no market is perfectly contestable (there are always some “barriers to contestability” – see your revision notes on barriers to entry). That said, it is also true that virtually every market is contestable to some degree even when it appears that the monopoly position of a dominant seller is
unassailable. This can have important implications for the competitive behaviour (conduct) of existing firms and clearly then affects the performance of a market from an economic efficiency viewpoint (e.g. allocative, productive and dynamic efficiency) Contestable markets and perfect competition - the differences
Contestable markets are different from perfect competitive markets. For example, it is feasible in a contestable market for one firm to dominate the industry, have price-setting power and also for firms in a market to produce a differentiated product both of which run counter to the assumptions behind the
traditional model of perfect competition. There are three main conditions for pure market contestability:
Perfect information and the ability and/or the right of all suppliers to make use of the best
available production technology in the market
The freedom to market / advertise and enter a market with a competing product The absence of sunk costs (i.e. low barriers to exit) – this reduces the risks of coming into a market
Sunk costs – a barrier to contestability Barriers to market contestability exist when there are sunk costs. These are costs that have been committed by a business cannot be recovered once a firm has entered the industry. It might be easier to think of sunk costs as costs that are unavoidable once they have been committed at a particular moment in time – a classic example being the money that the telecoms firms committed to winning the 3rd generation mobile phone licences at auction in 2000.
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When sunk costs are high, a market is more likely to produce a price and output similar to monopoly (with the risk of allocative inefficiency / market failure that follows on from this).
The Increasing Contestability of Markets
One feature of the British and European economy in recent years has been an increase in the number of
markets and industries that are genuinely contestable. Several factors explain this development: Entrepreneurial Zeal It is often the case that markets become more competitive because of the persistence of entrepreneurs
who simply do not accept that the existing market structure is a given. Decisions to enter markets where there are already dominant businesses with significant industry experience involve taking risks – but a new supplier may have the advantage of product innovation or a more competitive business model based on different pricing strategies.
Blueback Taxis The London taxi-cab market has just been shaken up by the arrival of a new, heavily branded
competitor. Blueback aims to become the “Starbucks” of the taxi market. What strategy is it using to enter the market? The London taxi market is highly fragmented - i.e. supplied by numerous small operators and is largely unbranded. The objective of Blueback is to rapidly grow market share by launching a clearly branded
service that will encourage taxi drivers to switch to the company. Blueback has taken a leaf out of low-cost airline Easyjet’s strategy book with the way it has developed its new service. Blueback has one, up-front pricing policy and runs only one type of vehicle, the Fiat
Multipla. Each vehicle carries the same, distinctive blue and silver livery. The drivers wear the same uniform and offer customers newspapers and mobile phone chargers as part of the onboard service. All drivers go through Blueback’s driver training programme and are licensed by the PCO. The Blueback service was developed from marketing research that asked people what they wanted from taxi hire. This covered areas such as ordering, pricing and experience of the service. The long-term objective of the
company is to have a fleet of 1000 vehicles within the next few years and to be the market-leading taxi operator in London
Metro Newspapers In a mature newspaper market, one growth story stands out. In the last five years, we have seen the rapid emergence of the Metro - a free morning newspaper targeted at urban commuters in major cities.
The paid-for daily newspaper is being challenged by an increasing number of free daily newspapers worldwide. Latest distribution statistics for Metro, the leading free newspaper, show the popularity of the Metro model shows no sign of weakening. Free distribution newspapers, like Metro, have rejected the traditional model. They have created one that relies completely on advertising revenue and establishing free distribution in and around the major public transportation systems of large cities. This has caused much concern amongst publishers of paid-for newspapers who fear the new free dailies will further erode their circulation and undermine their advertising base.
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De-regulation of markets – Also known as market liberalisation, de-regulation involves the opening up of markets to competition by reducing some of the statutory barriers to entry that exist. Good
examples of recent deregulation include the main utilities such as gas and electricity and also the liberalisation of telecommunications and postal services as part of the European Union competition
In postal services, all EU countries must open up business and household mail delivery services so that
there is at least one competing supplier to the dominant national postal service provider. The liberalisation is scheduled to be completed by 2007. Already the Royal Mail is negotiating agreements with other postal service companies to deliver their pre-sorted mail “the final mile” to consumers. In telecommunications, the advent of pre-carrier selection means that there is now increasing competition for land-line telephone services. British Telecom is now facing much greater competitive pressure from Just Talk, Talk-2, Talk-Talk (Carphone Warehouse) and other providersWarehouse announced that it was to offer households free local calls, challenging the dominance of BT in
the fixed line market. Competition Policy Tougher competition laws acting against predatory behaviour by existing firms are designed to make
markets more contestable. In both the UK and the EU this has included tougher rules against price fixing cartels. When market conte
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