Meaning

 Contestable market: any market structure where there is

a threat that potential entrants are free and able to enter
this market.
 By definition, a perfectly contestable market is one in
which there are no costs of entry and exit. So, only
perfect competition matches this ideal;
 monopolistic competition, with few relatively costless
barriers to entry and exit, can match it to some extent,
 oligopoly in certain situations
A contestable market can be particularly seen as a
means by which governments have sought to
deregulate markets.
 Thisrequires the removal of barriers to entry so
opening up the market to competition.
 It has had particular significance in the UK;
 the principle of contestability has been central to
the tremendous structural changes that have been
made especially to the service sector of the
economy with the introduction of new forms of
competition into formerly protected markets.
The important features of a contestable
markets
 ■ Free entry, which implies that new and existing providers will
have the same cost structure as in a perfectly competitive
market.
 ■ The number and size of firms are irrelevant. If a contestable
market has only a few large firms, any cost differences should be
a reflection of a decision by a particular firm to charge a given
price.
 ■ Only normal profits can be earned in the long run. If firms are
making abnormal profits, then this is the signal for others to enter
the market. This could be on a ‘hit and run’ basis – a firm sees an
opportunity, enters the market, collects the gains and leaves at
no cost.
 ■ The threat of potential entrants into the market is overriding.
Oligopolists and even a monopolist are obliged to offer consumers
the benefits that they would receive in a more competitive market
structure. Otherwise, new firms will enter from the pool of
potential entrants.
 ■ All firms are subject to the same regulations and government
control irrespective of size.
 ■ Mechanisms must be in place to prevent the use of unfair
pricing designed by established firms to stop new firms from
entering the market.
 ■ Cross-subsidization is eliminated since firms are unable to
make normal profits if they sell any of their services below cost.
Contestable markets in Airline industry
 The application of contestability to the airline market is particularly
interesting since, prior to deregulation, routes were strictly
regulated by governments through the International Air Transport
Association (IATA) and there was little competition.
 The ‘open skies’ policy of a deregulated market has led to lower
fares and a greater choice of routes for passengers.
 This has particularly been the case in the US domestic market and in
Europe, where new low-cost airlines such as easyJet and Ryanair
have entered the market and challenged the established national
carriers.
 More recently, deregulation has had a huge impact on the provision
of air services in southern and South East Asia.
Other examples of contestable markets
include:
 ■ local bus services and rail services in the UK through deregulation and
privatization


■ the provision of public services such as electricity,
gas and water supplies
■ telecommunications, particularly through the choice
of network suppliers
■ personal and corporate banking and finance through
deregulation.
Possibility of Contestable markets in any
nation
 The extent to which markets are contestable varies from one country to another. In theory
and in practice, any market, even a monopoly, can be contestable.
 State of affairs will come about if there is a pool of potential entrants waiting to enter a
market if they see existing fi rms making abnormal profits.
 The cost of entry and exit is the main factor that determines whether a market really is
contestable.
 Deregulation, the removal of barriers to entry, is the main way in which markets can be
opened up to competition.
 In many cases, deregulation has been implemented alongside a policy of privatisation.
 This twofold policy is one that has been implemented by many governments worldwide,
often in markets where previously the state or public sector has been the only provider of a
service.
Thank you