Contestable markets are those where there are low barriers to entry and exit, making it easy for new firms to enter and compete with existing ones.
- These markets are characterized by the threat of potential competition, which keeps existing firms on their toes and prevents them from exploiting their market power.
The key features of contestable markets are:
- Low barriers to entry and exit: There are no significant barriers to entry and exit, such as high capital requirements, regulatory hurdles, or exclusive access to key inputs or technologies.
- Free access to information: There is a free flow of information and no information asymmetry, which enables new entrants to make informed decisions about entering the market.
- No sunk costs: There are no sunk costs, meaning that firms can easily exit the market without incurring significant losses.
- No significant economies of scale: There are no significant economies of scale that provide an advantage to larger firms.
The implications of contestable markets are that existing firms must remain competitive, even in the absence of actual competition. The threat of entry and potential competition keeps prices low and quality high, benefiting consumers. New entrants can enter the market and compete on an equal footing with established firms, which encourages innovation and efficiency.
Contestable markets also have implications for government regulation. Because the market is self-regulating, government intervention may not be necessary to prevent abuse of market power. However, if barriers to entry exist or there is significant market concentration, regulation may be required to prevent anti-competitive behavior.