hi everybody a contestable market is one when there is a threat of competition not necessarily actual competition but what's so fascinating is that threat could be enough to affect the behavior of firms in the market we are going to study the characteristics first then the behavior of firms and then the pros and the cons so what characteristics need to exist for there to actually be a strong threat of competition into the market well fundamentally they've got to be low barriers to entry and exit there's got to be a large pool of potential entrance there's got to be good information of market conditions so new firms looking to join must know about costs they must know about technology so then if they were to enter the market they could compete on a Level Playing Field but also we say incumbent firms that means firms already in the market are subject to hit and run competition and this occurs because of low barriers to entry and exit this is when new firms enter the market quickly snatch some of the supern normal profit and then leave the market quickly before incumbent firms can react and lower their profit margins so we can see very clearly how because of these three characteristics the first three there is a serious threat of entry into the market but also we can add that because of the rise of Technology over the last few Decades contestability of markets has dramatically increased as well how how has technology increased contestability can we argue well we can say that technology has massively reduced barriers to entry and exit because businesses don't have to be physical anymore that reduces startup costs that reduces sunk costs it also means that firms don't need to hire as many workers necessarily and therefore don't need to meet as many regulations um but also it means that economies of scale are easier to achieve like technical economies of scale but it also means that advertising is easier as well and therefore we can overcome brand loyalty much easier so some major barriers to entry and exit have been reduced because of Technology but also technology we could argue has increased the pool of potential entrance in two ways technology has allowed for greater Innovation and therefore for new firms to come in with something brand new to disrupt markets take Uber and Airbnb as great examples but also technology has allowed for firms to find cheaper ways of producing things so therefore new firms don't have to necessarily be offering something new because of Technology but technology has allowed them to find lower cost of production methods to disrupt existing firms therefore increasing the pool of potential entrance technology we can also argue has increased information we could argue it's increased information because of the internet and therefore firms can find out easier uh about cost and technology in the market but also communication has improved and therefore it's easier to get that key information too so these are the characteristics of a contestable market if we're studying a perfectly contestable Market we just need to change that to no barriers to entry and exit and that to perfect information but the characteristics don't need to be of a perfectly contestable market for us to see outcomes of contestability let's look at the outcomes now well let's take the most extreme case of a monopoly Market a monopoly Market can also be contestable even though we say high barriers entry and exit there if they are still low enough for that to be a threat of Entry then this can be a contestable market and we see here that the monopo is currently pricing at pm and qm as we know currently making super normal profit but if this Market is contestable it makes no sense for this Monopoly to continue producing there if there is a strong threat of Entry a monopolist would move to PC and QC to where average cost is equal to average revenue this is the break even point in economics this is normal profit and is known as the limit price why would they move there just because of a threat of competition well one reason is lower your profit margins and try and eliminate that threat take away the incentive for firms to enter the market here as long as you're making supern normal profits there is a very strong incentive for these firms to actually enter and you as a firm do not want that at all you don't want actual competition so if you lower your profit margins move towards this limit price here you're limiting the competition into the market you're elating that threat when that threat goes away you can go back to making your super normal profit but the second reason why is by lowering your price and increasing your quantity you are prepared if that threat actually becomes real so if those firms actually enter the market you're prepared you can compete with lower prices and higher quantities okay so we get the idea that's how firms could react in a contestable market and we see the end results are very competitive outcomes lower prices and higher quantities now in reality guys AC equals AR is the extreme position that's the limmit price normal profit that's the extreme end point in reality we don't have to end up there in a contestable market there needs to be movement towards there that's the idea movement towards so lower prices higher quantities even if we're not exactly there it doesn't matter the basic concept we see lower prices and higher quantities now let's look at the pros and cons well movements towards competitive outcomes can give a similar benefits to a competitive market static efficiency benefits of allocative efficiency productive efficiency and X efficiency even though that isn't necessarily actual competition we get the benefits as if there is actual competition now our diagram doesn't show us all of these efficiencies but remember we're not saying that we are actually going to end up here at the limit price there is a movement towards that price and therefore there is a movement towards these efficiencies so don't worry if your diagram doesn't exactly show these efficiencies there is a movement towards them that's the key idea so what does allocative efficiency mean well it means there'll be lower price higher consumer surplus for consumers higher quantity higher quality in the market greater choice in the market productive efficiency implies greater exploitation of economies of scale and therefore lower costs lower prices for consumers X efficiency minimizing waste and therefore lower cost lower prices for consumers and we get that because firms have to be prepared for competition that's what they're doing here and that's why we see these competitive benefits very much in the interest of society but also we can say if there is higher quantity in the market there could be more jobs created labor is a derived demand remember but are there any potential issues with contestable markets well one issue we can say is a lack of dynamic efficiency and it's clear because of lower profit margins if this is how firms react then we might not get progress over time Dynamic efficiency over time yes but there is a very easy way to evaluate this and that is by saying if new firms come in with innovative ideas that in itself is the benefit of dynamic efficiency so that could be progress that could be Innovation which is what we could consumers love so even though yeah there might be a lack of it over time there is certainly innovation in the first place we could be concerned about cost cutting uh questioning here the ex efficiency benefits is cost cutting taking place in dangerous areas is it taking place with things like health and safety product safety environmental standards wages if that's the case that not that might not be desired in society we could argue creative destruction when new firms come in and that creativity that Innovation destroys existing firms and with that we see job losses so that allows us to question the job creation idea but a very simple way to uh to argue against that to evaluate that is by saying if overall the market is greater and new firms are very large in size then where firms have been destroyed and jobs have been lost those workers can move to newer firms and get jobs still in the same industry and we can also be concerned about anti-competitive strategies a good way to argue short run versus long run contestability here so in the short run there might be a contestable market and these benefits exist but over time if businesses use anti-competitive strategies like limit pricing but also maybe predatory pricing like flooding the market like using heavy advertising like merges in order to eliminate the threat then maybe contestability will not last over time these anti-competitive strategies will not give us the static efficiencies they could in the long run result in static inefficiencies let's look at some key evaluation points now the first one to consider is the length of contestability how long is the market contestable for if new technology or new firms coming in can patent their ideas then the Market's not going to be contestable over time if firms are using anti-competitive strategies the Market's not going to be contestable over time we can also look at the role of Technology we've said on the one hand how it could increase contestability but could it also reduce contestability especially because of patents copyrights that kind of thing which can really reduce contestability that's an interesting idea to bring in we could also argue that technology can improve information for firms in acquiring consumer data and therefore firms could actually practice price discrimination first deegree price discrimination a lot more first and third degree and that is not necessarily going to give us the static efficiency benefits that we want regulation we could argue regulation can minimize the issues of cost cutting in dangerous areas and anti-competitive strategies so you could say if there is already regulation that negates some of these cons it makes them less significant as cons and even if regulation doesn't exist we could argue that could be a role for regulation to reduce these cons regulation that protects product standards environmental standards health and safety standards but also regulation that prevents these anti-competitive strategies and we've already mentioned how we can evaluate Dynamic efficiency by looking at innovation in the first place in the market so that covers contestable markets guys fascinating to see how just the threat of entering into the market can really change outcomes in the market fascinating to study here hopefully you found that really interesting thank you so much for watching guys I'll see you all in the next video