Contestable markets Re-Cap & intro to govt intervention
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Transcript of Contestable markets Re-Cap & intro to govt intervention
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
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…
Note that the threat of
new entrants
may encourage positive OR
negative behaviour
by incumbents
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
Banking
Where are the opportunities to skim or hit and run?
Barriers to entry? Barriers to exit?
Use your checklist sheet
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
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…
– 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)
Revenue
Normal Profit Contrasted with Profit Maximisation
If the monopolist charges the profit-maximising price, then - if the market is contestable – the firm will be vulnerable to hit and run entry
The only way the 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
Output (Q)
Price
ARMR
MC
ATCP1
Q1
P2
Q2
No one in the industry
has any advantage
over anyone
else
Got this far in this lesson
Implications of contestable market theory
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
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
Why does the Government intervene to
maintain competition?
ORWhy does the Government seek to make markets more contestable?
Competition Policy
Promote Competition
ProtectConsumers
Enhance
Efficiency
Toughened since 1997
Assumption is that competition
eliminates x-inefficiencyBetter resource
allocationvs.
Economies of scale
Competition Policy
At the heart of competition policy is the comparison between Perfect Competition and Monopoly
Draw the two LR equilibrium diagrams
PC Consumer Surplus
Thank You!
PC and “Multi-plant” Monopoly compared
Quantity
Price
D=AR
LRS (=LMCm)
Pm
Qm
Ppc
QpcO
B
E
C
MR
Big Assumption!No cost difference between the two market structures
PC firms prepared to supply any
quantity at this price
The Monopolist at constant returns to scale can continue to supply with no
change in MC
PC firms supply Qpc at price Ppc
Monopolist supplies Qm at price Pm
Part of consumer surplus transferred to Monopoly as
profits
Deadweight loss = cost on society
Government Remedy =
Increase Competition!
Homework
Read and make notes on Anderton Ch 58 P380-382 Be prepared to hand in your notes at next
lesson
Define the term “Competition Policy” and explain why it exists
Plenary