Definition
A contestable market is an economic concept where there are low barriers to entry and exit, allowing potential competitors to easily enter or leave a market based on market conditions. Despite the number of firms operating, the market is always under threat of potential competition, maintaining competitive prices and quality. This concept assumes that even one single firm (in case of a monopoly) can operate effectively due to the constant prospect of competition.
Key Takeaways
- A contestable market is an economic concept that describes a market where there is freedom of entry and exit by businesses. This implies that even a single firm can be highly competitive if there’s a perceived threat of potential competition.
- Competitiveness in a contestable market is highly dependent on the barriers to entry and exit, and not solely on the number of firms partaking in the market. The lower the barriers, the higher the degree of market contestability.
- The theory of contestable markets suggests that when barriers to entry into a market are weak or non-existent, the prices, production, and efficiency result to a perfectly competitive equilibrium. This means potential competition can lead incumbent firms to behave as though they were in a perfectly competitive market, ensuring consumer benefits.
Importance
The finance term “Contestable Market” is important as it provides a comprehensive understanding of market dynamics, particularly in markets with few sellers.
It’s a concept which suggests that any market where entry and exit costs are low or non-existent is susceptible to “hit and run” competition, even if the market is dominated by one or few companies.
Regardless of the number of businesses operating, their pricing will be driven towards a competitive equilibrium because of the threat of potential entrants.
Thus, this concept forces businesses to maintain optimal operational efficiency and reasonable pricing, fostering healthy competition, and protecting consumer interests.
Explanation
A contestable market in the finance and economic world primarily serves the purpose of maintaining competitive conditions in the market landscape. This approach necessitates that the market remains accessible and viable for potential new entrants.
Regardless of the number of firms in operation, the important factor is that new firms can contest or challenge the market through potential or actual competition. This ensures that an optimal allocation of resources is maintained, promoting efficiency and competitive pricing in the market, which directly benefits the consumers.
The primary utilisation of a contestable market is to enforce restrictions on existing firms within a certain market from exercising monopolistic powers and distorting market conditions. When a market is regarded as ‘contestable’, it enhances the threat of competition and acts as an effective curb on the market power of existing firms.
Thereby, it also facilitates fair pricing, improved service delivery and innovation. Although actual competition is optimal, the threat of potential competition alone in a contestable market could encourage incumbent firms to behave competitively.
Examples of Contestable Market
Ride-hailing Apps Market: Uber and Lyft are the key players in this market, and it’s one where entry and exit costs are relatively low. Both companies entered the market and gained a significant market share from the traditional taxicab industry. As it’s tackable, new competitors, like Via and Gett, also entered.
E-commerce: Amazon, eBay, and Alibaba are popular e-commerce platforms. Though they’re key players, the market remains contestable as the barrier to entry is relatively low. Smaller companies like Etsy and Wish have managed to enter the market, offering unique products or cost advantages.
Streaming Services: Netflix, Hulu, and Amazon Prime Video ruled the market initially. However, the recent entry of platforms like Disney+, HBO Max, and Apple TV+ has made it evident that this market is contestable, allowing companies with innovative ideas and strategies to secure a market share.
FAQs about Contestable Market
What is a Contestable Market?
A contestable market is a type of market structure where there may be one or a number of companies operating in competition with each other, but where other companies are able to enter the market freely and provide competition.
What are the characteristics of a Contestable Market?
The main characteristics of a Contestable Market include low entry and exit barriers, potential predatory behaviour by incumbent firms, and the significant role of innovation and entrepreneurship. Also, the firms in a contestable market are price-takers.
What is an example of a Contestable Market?
An example of a Contestable Market includes the airline industry where although there are major market players, new airlines can easily enter the market to provide competition.
What is the importance of a Contestable Market?
The main importance of a Contestable Market is that it promotes competition, which in turn drives down prices, encourages innovation and improves the quality of products or services offered to consumers.
What are the limitations of a Contestable Market?
There are several limitations such as the possibility of large firms engaging in anti-competitive practices, economies of scale that may dissuade new entrants, and the possibility of technology or infrastructure acting as a significant barrier to entry.
Related Entrepreneurship Terms
- Perfect Competition
- Market Entry Barriers
- Monopolistic Competition
- Hit and Run Competition
- Market Efficiency
Sources for More Information
- Investopedia: An online resource for understanding finance and investing. They offer definitions, tutorials, and articles on a vast range of finance-related topics, including contestable markets.
- Economics Online: This site provides comprehensive online resources on economics topics, and has sections dedicated to business economics, which may cover contestable markets.
- Corporate Finance Institute: The CFI is a professional training and certification organization, they offer a wealth of free online resources for corporate and finance professionals, including articles on economic concepts like contestable markets.
- Britannica: A widely respected educational resource, Britannica provides informative articles on a vast array of subjects including economics and the concept of contestable markets.
