Contestable markets

7 Key excerpts on "Contestable markets"

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  eBook - ePub

  Principles of Microeconomics

  • Peter Curwen, Peter Else(Authors)
  • 2006(Publication Date)
  • Routledge

    (Publisher)

  Any contestable market must exhibit the ideal behaviour to be expected under perfect competition. Hence two competitors are sufficient to trigger off contestable market behaviour. A final critical point to be made by way of introduction to Contestable markets is that, whereas traditional models start out by taking the structure of an industry as exogenously given, and then proceed to investigate how each structure affects the determination of prices, output and so forth, the contestable market model assumes that each industry’s structure is determined endogenously by technical conditions reflected in the cost functions of firms.. Entry and exit characteristics As denoted in Table 15.1, there are no entry barriers in a contestable market. This is to be taken to mean not simply that entry is necessarily costless, but rather that an entrant can produce products that consumers will treat as comparable to those of incumbent firms with respect to such matters as quality, and that the existing price levels are sufficiently attractive as to suggest to the potential entrant that he can make a worthwhile profit. In other words, the entrant must be able to operate with a cost structure comparable to that of incumbent firms and cannot be prevented from attaining it. In addition, there must be absolute freedom of exit in a contestable market so that any entry costs can always be recouped when a firm leaves the industry. A critical requirement here is the absence of sunk costs, which are costs that cannot be recovered on exit from the industry. For example, mining operations involve considerable initial expenditures on the drilling of mine shafts, tunneling and the like, which cannot, in most cases, be recovered on exit from the industry because the facilities created have little value in alternative use. It is physically impossible to transfer them to another site and they are unlikely to have any value in alternative uses on their existing site

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  Barriers to Competition

  The Evolution of the Debate

  • Ana Rosado Cubero(Author)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  contestable market to improve the theory of industry structure. Baumol and Willig wrote together about fixed cost and sunk cost as barrier to entry. In order to shed light on this issue, they defined fixed costs as those borne by firms even in the long run, which makes them production costs. Whereas sunk costs disappear in the long run. Sunk costs are those costs which that the firm has to lay out at the beginning but if the business works they are built into accounts as initial investment. Sunk costs become a barrier to entry when the business doesn’t work because the investor risks his capital without the possibility of recovering his money. In this sense, the amount of capital that a firm has to risk in order to improve its market share, even in order to enter in the market, can be considered a significant data of the level of the barrier to entry. In conclusion, a contestable market demands two requisites: no artificial barriers to entry, and that fixed costs are not sunk costs.

  William Baumol13 and Robert Willig14 wrote an article in 1981 entitled ‘Fixed Costs, Sunk Costs, Entry Barriers and Sustainability of Monopoly’ which was chapter 10 of their most important book, written jointly with John Panzar15 and published in 1982 with the title of Contestable markets and the Theory of Industry Structure. In 1982,

  Baumol wrote an article for the American Economic Review

  following the path of Contestable markets. The target was to build a new theory of Industrial Structure. We have blended both articles and book, in order to make the comprehension of the whole proposal easier. Their analysis provides a generalization of the concept of a perfectly competitive market. Into a market oligopolist structure and identical behaviour they included free entry from their previous dependence on the conjectural variation of incumbents. In their words:

  A contestable market is one into which entry is absolutely free, and exit is absolutely costless. We use “freedom of entry” in Stigler’s sense, not to mean that it is costless or easy, but that the entrant suffers no disadvantage in terms of production technique or perceived product quality relative to the incumbent and that potential entrant find it appropriate to evaluate the profitability of entry in terms of the incumbent firms’ pre-entry prices.16

  In a perfect contestable market, no cross subsidy is possible, that is, no predatory pricing can be used as a weapon of unfair competition. The average cost cannot be defined. Pricing behaviour and market structure should be determined simultaneously and endogenously with the analysis of the other variables more traditionally treated in the theory of the firm and the industry.

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  Managerial Economics

  The Analysis of Business Decisions

  • Stephen Hill(Author)
  • 2016(Publication Date)
  • Red Globe Press

    (Publisher)

  The manufacturer of Kelloggs Cornflakes has, by definition, a monopoly of their production, but hardly a monopoly over cornflakes, and still less a monopoly over breakfast cereals. The chain of close substitutes is relentless, with monopoly power continually being eroded by product development and the introduc-tion of new products. In addition to the formal models of market structure described above, economists have devised a series of more relaxed competi-tive definitions designed to be more representative of actual mar-kets. Competition is said to be workable or effective if consumers are offered real alternatives sufficient to enable them to influence price, quantity or quality by shifting their purchases from one supplier to another . Such a competitive definition eschews the formality of concrete assumptions about the number and size of firms or the existence or otherwise of product differentiation, and concentrates upon the essential competitive attribute of consumer choice. The test of workable competition is the availability of genuine alterna-tives for consumers. The theory of Contestable markets relates most generally to situations of natural monopoly, whereby the cost structure of the industry suggests efficient production would be by a single seller. In such a situation, the market is contestable, despite its cost structure, if there is freedom of entry and exit. If the natural monopolist charges an excess price, profitable entry is possible. The threat of potential entry is sufficient to force the existing firm to be efficient and keep prices down. The efficient markets hypothesis suggests that the market structure of a particular industry is unimportant, since the competitive nature of financial markets will force all firms to be efficient and profitable. According to this hypothesis firms not performing as well as they could will see their share values fall, and risk being taken over by more efficient and profit-seeking owners.

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  Economic Freedom and the American Dream

  • J. Shaanan(Author)
  • 2010(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  However, those forms of competition are not usually regarded as equally beneficial as price compe- tition because the purpose of some of these types of competition is strictly redistributive. 16 It is also doubtful whether acceptance of a different defini- tion of a free market, requiring only the lack of barriers to entry and exit, but without price competition, yields a more favorable diagnosis. Here too debates abound over what constitutes a barrier and whether the existence of only a small number of firms in an industry signifies their efficiency or their power to deter entry. In addition, bargaining power is frequently tilted in a contrived manner, sometimes even with government help, against buyers and smaller sellers. Not only is the economic freedom of many individuals and firms lessened as a result, but such markets are not in conformity with Adam Smith’s original intent. One might add that, legal issues aside, fraud and deception and misleading advertising also violate some definitions of free markets. Finally, in evaluating whether an industry resembles a free market or not, the extent of government intervention is crucial. Regardless of the form of pricing, if an industry or some of its members receive subsidies and other forms of government help, (as discussed in Chapter 8), then this is inconsistent with the definition of a free market. 17 Government may not set the price, but its assistance affects it. 10.2 Competition in Manufacturing Monopoly is relatively rare in U.S. manufacturing industries, but important industries are oligopolies. In analyzing the degree of competition, one mea- sure used by economists is an industry’s four firm concentration ratio (C4), which is the combined market share of the four largest firms. In 1992, less than 5 percent of industries had a C4 greater than or equal to 80 percent, while at the other extreme, less than 18 percent of industries had a C4 less than or equal to 20 percent.

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  Contestable Markets Theory, Competition, and the United States Commercial Banking Industry

  • Ross N. Dickens(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  If incumbents’ price is not affected by a change unless actual entry occurs, the inference is of noncontestability” (p. 50). Product innovations and regulatory change provide just such a new competitive arena. If commercial banks were earning economic profits based on barriers to entry (or were expected to earn such profits in the future), those (expected future) profits should decline as others were allowed to offer the same products. A decline before entry is consistent with Contestable markets theory while a decline after entry is more in line with the traditional SCP model. 3 APPLICATION OF Contestable markets THEORY TO COMMERCIAL BANKING This paper examines commercial banking products and services using CMT as set forth in Baumol (1982) and Baumol, Panzar, and Willig (1982). Bailey and Baumol (1984) state that “neither large size nor fewness of firms necessarily means that markets need function unsatisfactorily” (p. 111)

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  The Global Body Market

  Altruism's Limits

  • Michele Goodwin(Author)
  • 2013(Publication Date)
  • Cambridge University Press

    (Publisher)

  Dying 4 For a defense of this proposition, see Richard A. Epstein, The Neoclassical Economics of Consumer Contracts, 92 Minn. L. Rev. 803 (2008). 5 Crude oil is available in many varieties and qualities, depending on its specific gravity and sulfur content, which depend on where it has been pumped from. If no other infor- mation is given, an oil price appearing in UK and other European media reports will probably refer to the price of a barrel of Brent blend crude oil from the North Sea sold at London’s International Petroleum Exchange (IPE). Oil Markets Explained, BBC News, Oct. 18, 2007, http://news.bbc.co.uk/2/hi/business/904748.stm. 6 See, e.g., Agriculture Marketing Service, U.S. Dep’t Agric. http://www.ams.usda.gov/ AMSv1.0/ (follow Grading, Certification and Verification). How to Create Markets in Contestable Commodities 47 tenants seek to pass on the unit to their second cousins. Departing tenants will sell keys to the apartment five times over. Irate landlords will turn off the heat to drive tenants out of their units – all because prices are kept arti- ficially low. Ah, for a whiff of deregulation. Likewise the manifold difficul- ties in ethanol markets with their grotesque combination of tariff walls and domestic subsidies tell the same sorry story. 7 Regulation creates all sorts of strategic options that crowd out sensible, voluntary exchanges. It is not conceivable to think of any advanced society that could rid itself of residen- tial leases or farm production. But lest people attack the ills of a competi- tive market, they should think long and hard about the painful outcomes in regulated markets – a result that holds whether we deal with good widgets or bad ones. Organized Markets and Contestable Commodities These observations about markets in general set the stage for the problem of this book. No longer can we assume that we are dealing with widgets and gidgets tradable in competitive markets.

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  The Driving Force of the Market

  Essays in Austrian Economics

  • Israel M Kirzner(Author)
  • 2000(Publication Date)
  • Taylor & Francis

    (Publisher)

  It is reasonable to try to formulate the conditions defining a monopolized market, but it is almost incoherent to ask for the conditions that must be satisfied in order for a market process to be described as being competitive. A market process is competitive by the very nature of being a market process. Sometimes I try to characterize the competitive nature of the market process by drawing attention to “freedom of entry” (or its correlate, “absence of privilege”), but it would be confusing to state that a market process is competitive according to the extent to which it permits free entry. A market process consists of the decisions of those who enter or who might enter. At most one can say that the extent to which a social process can be described as a market process depends on the extent to which freedom of entry to buy and sell are permitted. Freedom of entry is indeed a defining characteristic of competition, but only because the market process is, by definition, a competitive one.

  Admittedly all this does create a certain difficulty for economic terminology. A market may be monopolized or it may not be monopolized. How am I to describe a market in which exclusive monopolistic privilege is absent? Surely the adjective “competitive” has a reasonable claim, in economic history and in the history of economic theory, to be the label describing the absence of exclusive privilege? The terminological difficulty is a real one, and is, probably, responsible in part for the extraordinary confusion which has surrounded the concepts of monopoly and competition during the twentieth century. It is, therefore, useful to examine one recent example of the problem, an example taken from an internal disagreement within Austrian economics.

  THE MISESIAN THEORY OF MONOPOLY

  Standard theory defines competition in terms of the degree of elasticity of demand facing the firm. In the case of perfect competition this elasticity is infinite; there are so many firms in the industry, and knowledge is so perfect, that no one of them can sell anything above the going market price. The polar opposite case is then that of a single firm selling in a well-defined market. With outside entry somehow absent, this monopolist then confronts the market demand curve, and chooses his profit-maximizing position accordingly. Clearly, if this monopoly position does indeed yield pure profit, the question arises as to why outside entry is indeed absent. Why don’t others enter in an attempt to grasp some of this profit? It was this insight which inspired Mises to recognize that, within the market system itself, the only possible source for monopoly was sole ownership of some scarce essential input. (Of course Mises made it clear that government intervention in a market system can—and has historically very frequently indeed—generated monopolized markets.)

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