Contestable markets theory
In economics, the theory of contestable markets, associated primarily with its 1982 proponent William J. Baumol, holds that there exist markets served by a small number of firms, which are nevertheless characterized by competitive equilibria (and therefore desirable welfare outcomes) because of the existence of potential short-term entrants.
A perfectly contestable market has three main features. It is a market that has -
A perfectly contestable market is not possible in real life.[citation needed] Instead, we talk about the degree of contestability of a market. The more contestable a market the closer it will be to a perfectly contestable market.
Economists argue[citation needed] that determining price and output is not actually dependent on the type of market structure, in other words whether it is a monopoly or perfectly competitive market, but rather the threat of competition. Hence, for example a monopoly protected by high barriers to entry (e.g. it owns all the strategic resources) will make supernormal or abnormal profits with no fear of competition. However, in this same case if it did not own the strategic resources for production then other firms could easily enter the market, leading to higher competition and thus lower prices, thus making the market more contestable.
Sunk costs are those costs that cannot be recovered after a firm shuts down. For example a new firm enters the steel industry. For this, the entrant needs to buy new machinery. Now, if for any reason this new firm could not cope up with the competition of the incumbent firm then it will plan to move out of the market. However, if the new firm cannot use or transfer the new machines that it bought for the production of steel to other uses in another industry, then these fixed costs on machinery become sunk costs. Hence if there are sunk costs present in the market it impedes the first assumption of no exit barriers. Hence this market will not be contestable and no firms would enter the steel industry.
It is very important for firms to have access to the same level of technology as that helps determine the average cost of the product. An incumbent firm having more knowledge and access to a technology for the production of a commodity could enjoy higher economies of scale in the form of lower average cost of production. A new firm entering the market, with insufficient information or technology, could incur a higher average cost of production, and therefore be unable to compete with the incumbent firm. This would lead to the incumbent firm enjoying monopoly power and supernormal profit in the market, as the new firm will exit the market. A solution to this problem could be governments providing equal access to knowledge and technology, as well as financial resources for the same.
Its fundamental features are low barriers to entry and exit; in theory, a perfectly contestable market would have no barriers to entry or exit ("frictionless reversible entry" in economist William Brock's terms). Contestable markets are characterized by "hit and run" competition; if a firm in a contestable market raises its prices much beyond the average price level of the market, and thus begins to earn excess profits, potential rivals will enter the market, hoping to exploit the price level for easy profit. When the original incumbent firm(s) respond by returning prices to levels consistent with normal profits, the new firms will exit. Because of this, even a single-firm market can show highly competitive behavior.
The applicability of the theory to real-world situations may be questioned, however, particularly as there are very few markets which are completely free of sunk costs and entry and exit barriers. Low-cost airlines remain a commonly referenced example of a contestable market; entrants have the possibility of leasing aircraft and should be able to respond to high profits by quickly entering and exiting. However, it is now generally admitted that Baumol's judgment that the US airline industry was therefore best left deregulated was incorrect, since the now duly deregulated industry is "well on its way" to evolving into a concentrated oligopoly. More generally, experimental evidence collected since the publication of Baumol's paper has suggested that perfectly competitive markets would - if they existed - behave in the way Baumol outlined, the performance of imperfectly contestable markets (i.e. real-world markets) depends "on actual rather than potential competition", perhaps in part due to the range of "strategic responses" available to incumbents that were not considered by Baumol as part of his theory.
The theory of contestable markets has been used to argue for weaker application of antitrust laws, as simply observing a monopoly market may not prove that a firm is exploiting its market power to control the price level. Baumol himself argued based on the theory for both deregulation in certain industries and for more regulation in others.

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Contestable market - Wikipedia, the free encyclopedia
In economics, the theory of contestable markets, associated primarily with its 1982 proponent William J. Baumol, holds that there exist markets served by a small ...
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Contestable Market Theory Definition | Investopedia
An economic concept that refers to a market in which there are only a few companies that, because of the threat of new entrants, behave in a competitive ...
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The Theory of Contestable Markets - Krannert School of Management
The theory of contestable markets was advanced as a generalization of the theory of ... theory of contestable markets has made toward its goals, and of empirical.
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Contestable Markets: An Uprising in the Theory of Industry Structure ...
Contestable Markets: An Uprising in the. Theory of Industry Structure. By WILLIAM J. BAUMOL*. The address of the departing president is no place for modesty.
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Contestable Market Theory as a Regulatory Framework: An Austrian ...
contestable markets in their 1982 book, Contestable Markets and the Theory ... the theory of contestable markets can be extremely helpful in the design of.
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Monopoly - Contestable Markets - Tutor2u
The theory of contestable markets suggests that even if there is only one seller, the seller may be forced to act as if there were many more. In contrast, there are ...
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Contestable Markets - Tutor2u
Sep 23, 2012 ... Contestable Markets. ... For a contestable market to exist there must be low barriers to entry .... Monetarism and the Quantity Theory of Money
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Price Takers and Price Makers – Pricing Power - Tutor2u
Sep 23, 2012 ... Contestable markets. Contestable markets are markets where the entry and exit costs are low. .... Monetarism and the Quantity Theory of Money
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Contestable markets - Economics Online
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some thoughts on the theory of contestable markets which suggests that any market might in fact be contestable - even monopolies...
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[PDF]The Theory of Contestable Markets - Krannert School of Management
The Theory of Contestable Markets. Stephen Martin. Department of Economics. Purdue University smartin@purdue.edu. July 2000 ...
Baumol, Panzar, and Willig's Theory of Contestable Markets and ...
Sep 16, 2012 ... Baumol, Panzar, and Willig's Theory of Contestable Markets and Industry Structure: ... MPRA Paper from University Library of Munich, Germany.
[PDF]Contestable Markets: An Uprising in the Theory of Industry Structure ...
Contestable Markets: An Uprising in the Theory of Industry Structure ... formulation of the theory-most notably ..... tation at New York University, Thijs ten. Raa has ...
Quality in contestable markets : theoretical notes on a historical ...
Quality in contestable markets : theoretical notes on a historical problem (1985). Author: Rashid, Salim; Khan, M. Ali; University of Illinois at Urbana-Champaign.
Deregulation and the Theory of Contestable Markets - LexisNexis
Professor of Economics, Princeton and New York Universities. ... Next, we examine the efficiency attributes of contestable markets, the conditions that contribute ...
[PDF]Quality in contestable markets - Ideals - University of Illinois at ...
University of Illinois at Urbana-Champaign. January, 1985. Quality in Contestable Markets: Theoretical Notes on a Historical Problem. Salim Rashid, Associate ...
Contestable markets - Economics Online
An outline of the theory of contestable markets. ... Read the full story. The UK's top 40 Universities for Economics. Public spending - £11.5bn cuts announced.
[PDF]Contestable Markets and the Theory of Industry Structure: A ... - Jstor
University of Wisconsin-Madison. Contestable Markets and the Theory of Industry Structure is a comprehen- sive integration, expansion, and application of the ...
[PDF]The Evolution of Contestable Markets: A Computing Simulation
1Southwest University of political Science and Law, Chongqing, China; 2Communication University of China, ... The Contestable markets theory emphasizes the.
Books on the term Contestable markets theory
Contestable Markets and the Theory of Industry Structure
Contestable Markets and the Theory of Industry Structure
William J. Baumol, 1982
This classic text presents an integrative theory of what determines prices and industrial structure in contestable markets. The exposition extends theory and technique and suggests some unique perspectives from which to view regulatory and deregulatory policy. All analysis is done both graphically and mathematically, and in certain chapters the aut...
The Theory of Contestable Markets: Applications to Regulatory and Antitrust Problems in the Rail Industry (Contributions...
The Theory of Contestable Markets: Applications to Regulatory and Antitrust Problems in the Rail Industry (Contributions...
1990
This book provides a comprehensive analysis of the application of the new theory of contestable markets to the problem of the transition to deregulation in regulated industries. It offers an extensive review of both the theory and practice of contestable markets, as well as guidelines for the practical application of the theory to regulated industr...
Economics
Economics
Anderton
It is not necessarily possible to predict the exact output of an individual firm in a contestable market if average cost curves are L shaped. Contestable market theory us neo-classical theory Many, if not most, markets in the UK and in other ...
The Theory of Industrial Organization
The Theory of Industrial Organization
Jean Tirole, 1988
"I think that this book will fill a tremendous void in the textbook market for advanced undergraduate and graduate level courses in industrial organization and applied microeconomics. The strength of Tirole's work is his masterful synthesis of analytical development and intuitive discussion. Consequently, he makes understandable to the re...
Microeconomics (Arnold), 11th ed.
Microeconomics (Arnold), 11th ed.
Roger A. Arnold, 2013
Perhaps the most important element of a contestable market is so-called hit-and- run entry and exit. New entrants can enter (hit), produce the product, take profits from current firms, and then exit costlessly (run). The theory of contestable ...
The theory of contestable markets: applications to ...
The theory of contestable markets: applications to ...
William B. Tye, 1990
This book provides a comprehensive analysis of the application of the new theory of contestable markets to the problem of the transition to deregulation in regulated industries.
The Economics Book
The Economics Book
2012
*Starred Review* To most readers, the term engaging economics book is an oxymoron. This cleverly presented new volume may change that. The Economics Book takes a unique approach to elucidating this often murky subject through well-written entries. Arranged by both subtopic and time frame, the history of economic theory, notable world events, and bi...
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Contestable markets theory
Contestable market | Policonomics
Contestable markets are those in which the short-term threats from potential competitors exert such a degree of pressure over the incumbents, that their behaviour is conditioned. Contestable markets are therefore in a competitive equilibrium even though the market can be considered to have a relatively small number of firms, meaning these could as well behave as in imperfect competition.
www.policonomics.com/contestable-market/
"Competition and Contestability in Central and Eastern European Banking" by Semih Yildirim
This study attempts to analyze the effects of financial liberalization and deregulation on competitive conditions in the banking industries of fourteen Central and Eastern European (CEE) transition economies using firm-level data for the period 1993-2000. The basis for the evaluation of competitive situation is the extant oligopoly theory in the new industrial organization literature, specifically, the competition model developed by Rosse and Panzar (1977), and Panzar and Rosse (1982,1987). This approach relies on the premise that, in their long-run equilibrium, banks will employ different pricing strategies in response to a change in input costs depending on the market structure in which they operate. The results of the competition analysis suggest that the banking markets of CEE countries cannot be characterized by the bipolar cases of either perfect competition or monopoly over 1993-2000 except for FYR of Macedonia and Slovakia. That is, banks earned their revenues as if operating under conditions of monopolistic competition in that period. Overall, large banks in transition countries operate in a relatively more competitive environment compared to small banks, or in other words, competition is lower in local markets compared to national and international markets. Finally, the cross-sectional analysis of competitive structure shows initially a decreasing trend between 1993 and 1996 and a subsequent increasing trend in competitive conditions after 1996. Having determined the degree of competition, this study further examines the relationship between competition, concentration and bank performance. The result of the empirical analysis does not yield any significant relationship between competition and concentration, suggesting the possibility that higher contestability, in part due to the recent technological advances, have resulted in an overall increase in competition, despite high level of market concentration. Furthermore, I find that the average bank deviates substantially from the best-practice frontier. The managerial inefficiencies in CEE banking markets were found to be significant, with average cost efficiency levels of 72 and 76 percent by the "Distribution-free Analysis" (DFA) and the "Stochastic Frontier Analysis" (SFA). These average estimates suggest that an average bank would have incurred 28 to 24 percent less of its actual costs had it matched its performance with the best-practiced bank. The alternative profit efficiency levels are found to be significantly lower relative to cost efficiency. According to SFA, approximately one-third of banks’ profits are lost to inefficiency, and almost one-half according to the DFA. In explaining the cross-sectional determinants of efficiency, the results suggest that higher efficiency levels
trace.tennessee.edu/utk_graddiss/2351/
Theory of Contestable Markets @ Intelligent Economist
www.intelligenteconomist.com/theory-of-contestable-markets/
hyperborea: Critique of Contestable Market Theory
From 1979 to 1981 there was a lot of "hit and run entry" into the airline industry. This partly influenced George Baumol in 1982 to write his restatement of the potential competition doctrine in its new form, contestable market theory.
aeconomics.blogspot.com/2008/03/critique-of-contestable-market-theory.html
Daily Eli: The Economist Cover, and contestable market theory
The economist has this image on their cover When you think about it, these internet firms aren't really in much competition with each other. Is Facebook really providing the same service as Amazon? Are they really even close? Contemporary economics has to present these firms like warring.
dailyeli.blogspot.com/2012/12/the-economist-cover-and-contestable.html
SGS Micro Blog: What is the theory of contestable markets?
As Chapter 9 explains, in recent years, much of the debate about the best way of dealing with the problems posed by monopoly has reflected the growing influence of contestable market theory. Before the advent of this theory (and of the wider free-market revival of which the theory of contestable markets is a part), competition policy was generally interventionist.
sgsmicroblog.blogspot.com/2010/11/what-is-theory-of-contestable-markets.html
The Age of Contestability, Bryan Caplan | EconLog | Library of Economics and Liberty
econlog.econlib.org/archives/2012/03/the_age_of_cont.html
Schmidtomics - An Economics Blog: What is the theory of contestable markets?
Here in the village of Leysin, Switzerland, there is one firm that sells kebabs. The owner of this restaurant therefore has a monopoly on the sale of kebabs on this mountain.
schmidtomics.blogspot.com/2010/02/what-is-theory-of-contestable-markets.html
Mikeroeconomics: Contestable Market and Wal-Mart
William Baumol advanced a theory that even a monopolized market can be penetrated by smaller firms with the same cost curves. Dr.
mikeroeconomics.blogspot.com/2007/05/contestable-market-and-wal-mart.html
A Research on New Contestable Markets Theory and Government’s Structure Innovation of New Economic | Economics Papers,Economics Term Paper,Economics Research Paper
Since entering 1990s, three major variation tendencies of the international economy: The economic globalization, networked, economic knowledge of economy (information) melt more and more obvious. This three major variation tendencies have promoted the forming of together. Under the new economic condition, with the fast development of the network technology and IT technology, the ones that begin by industrial economy times in the organizational forms of enterprises move towards the horizontal int
www.economics-papers.com/a-research-on-new-contestable-markets-theory-and-governments-structure-innovation-of-new-economic.html
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