Download 14_Finish-contestability-and-intro-to-govt

Contestability recap
Lesson objectives

Recap how markets can become more contestable

Differentiate the level of contestability between markets
and what determines it using industry examples

Explain using a diagram the implications of contestable
market theory on firms in the industry

Introduce the economic underpinnings of “competition
policy”
Contestable Markets Recap – New
entrants

‘Hit and Run’ tactics – enter the
industry, take the profit and get out
quickly (possible because of the
freedom of entry and exit)

Cream-skimming – identifying parts
of the market that are high in value
added and exploiting those markets
Contestable Markets Recap
Key characteristics:
 No (low) barriers to entry or exit
 No (low) sunk costs
Note that
the threat of
new
entrants
may
encourage
positive OR
negative
behaviour
by
incumbents

Firms’ behaviour influenced by the threat
of new entrants to the industry

Firms may deliberately limit profits made
to discourage new entrants entry - limit pricing
Firms may attempt to erect artificial barriers to
entry – e.g…

Contestable Markets

Over capacity – provides the opportunity to
flood the market and drive down price in the
event of a threat of entry

Aggressive marketing and branding
strategies to ‘tighten’ up the market

Potential for predatory or destroyer pricing

Find ways of reducing costs and increasing
efficiency to gain competitive advantage
Barriers to Contestability

No market is perfectly contestable – there are always some
barriers!

Existing firms can engage in predatory behaviour to make entry
more costly to new rivals

Raising rivals’ costs
–
–


Vertical integration means that some firms act as component
suppliers to other firms in their industry – they have control over the
supply-chain (also known as vertical restraint)
The use of import tariffs to increase the relative prices of overseas
output
Reducing rival’s revenues – “bundling”
A monopoly can use profits in one market to boost market power
in another (cross-subsidisation)
Bundling – Anti-Competitive
Behaviour?

Product bundling is a marketing ploy of giving away a
relatively cheap product with a relatively expensive one
to attract customers

Bundling can have the effect of tying the consumer to
both products

This is particularly prevalent in computer manufacturing
where the product comes with specific items of software
already pre-loaded
Use your checklist
sheet
Banking



Where are the opportunities to
skim or hit and run?
Barriers to entry?
Barriers to exit?
Banking


Where are the opportunities to
skim or hit and run?
Barriers to entry?
–
–
–
–

Brand loyalty
Marketing
Legal
Financial
Barriers to exit?
Evaluating Contestable Markets
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




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There are no perfectly contestable markets
What matters is the degree of competition / contestability
The idea is that what matters is not so much competition within a
market, but rather competition for a market.
What also matters is the threat of entry of new suppliers – but this
may not be enough to affect the behaviour of existing firms
The absence of competition in a market over a long period of time
does not necessarily suggest a lack of contestability
Structural changes in costs in different industries can change the
degree of contestability
Contestability may force existing firms away from profit-maximising
behaviour (e.g. towards sales-revenue maximisation)
Over to you…
–
Revenue
Draw
Monopolist’s
profit maximising
equilibrium
–
How might the
monopolist react
to the threat of hit
and run entry by
removing the new
entrants’
incentive?
Output (Q)
Normal Profit Contrasted with
Profit Maximisation
Price


No one in
the
industry
has any
advantage
over
anyone
else
If the monopolist
charges the profitmaximising price,
then - if the market
is contestable – the P1
firm will be
vulnerable to hit
and run entry
The only way the
P2
monopolist can
avoid this
happening is to set
the price equal to
average cost, so
that there are no
supernormal profits
to act as an
incentive for entry
MC
Got this far in this lesson
ATC
AR
MR
Q1
Q2
Output (Q)
Implications of contestable market
theory

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

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The number of firms in an industry is irrelevant in terms of
economic efficiency
Abnormal profits attract new entrants driving down prices
and ensuring economic efficiency
All markets (excluding natural monopoly) can be efficient
so long as they are contestable
Shifts the emphasis of government competition policy
away from number of firms towards reducing barriers to
entry in an industry
Potential competition may be more important for
economic efficiency than actual competition
Contestable Markets

Examples of markets exhibiting contestability
characteristics:
–
–
–
–
–
Financial services
Airlines – especially flights
on domestic routes
Computer industry – ISPs, software, web
development
Energy supplies
The postal service?
N.B.

Exam board likes the topic of contestability

Remember the threat of competition can be
as effective as actual competition

Key is the relationship between sunk costs
and the degree of contestability
Contestability


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
10 minute essay
“To what extent is the UK banking market a
contestable market”
Agree a structure as a group
Divide up the work amongst yourselves
Write the bullet points of an essay
Government intervention to
maintain competition in markets
OR
Why does the
Government
seek to make
markets more
contestable?
Why does the Government
intervene to
maintain competition?
Toughened since
1997
Competition Policy
Promote
Protect
Competition
Consumers
Enhance
Better resource
allocation
vs.
Economies of
scale
Efficiency
Assumption is
that competition
eliminates xinefficiency
Competition Policy


At the heart of competition policy is the
comparison between Perfect Competition
and Monopoly
Draw the two LR equilibrium diagrams
Big Assumption!
No cost difference
between the two
market structures
PC and “Multi-plant” Monopoly compared
Part of consumer surplus
transferred to Monopoly as
profits
Price
Deadweight loss
= cost on society
B
Pm
Thank PC
You!
Ppc
Consumer Surplus
E
LRS (=LMCm)
PC firms prepared to
supply any quantity
at this price
C
MR
O
Monopolist supplies
Qm at price Pm
Qm
The Monopolist at
constant returns to
scale can continue
to supply with no
change in MC
Qpc
D=AR
Quantity
PC firms supply Qpc
at price Ppc
Homework



Read and make notes on Anderton Ch 58
P380-382
Be prepared to hand in your notes at next
lesson
Plenary
Define the term “Competition Policy”
and explain why it exists