Editing Contestable market (section)

==Theory==
A perfectly contestable market has three main features:
#  No entry or exit barriers
#  No [[sunk costs]]
#  The same level of technology is available to [[incumbent]] businesses and new entrants.

A perfectly contestable market is not possible in real life. Instead, the degree of contestability can be observed within markets.{{examples|date=November 2024}} The more contestable a market is, the closer it will be to a perfectly contestable market.

Some economists argue that determining price and output is actually dependent not on the type of market structure (whether it is a monopoly or perfectly competitive market) but on the threat of competition.<ref name="EO" >Critic Capital LLC, [https://www.economicsonline.co.uk/Business_economics/Contestable_markets.html "Contestable  markets"], Economics Online (at www.economicsonline.co.uk).</ref>

Thus, for example, a monopoly protected by high barriers to entry (for example, it owns all the strategic resources) will make supernormal or abnormal profits with no fear of competition. However, in the same case, if it did not own the strategic resources for production, other firms could easily enter the market, which would lead to higher competition and thus lower prices. That would make the market more contestable. Sunk costs are those costs that cannot be recovered after a firm shuts down. For example, if a new firm enters the steel industry, the entrant needs to buy new machinery. If, for any reason, the new firm cannot cope with the competition of the incumbent firm, 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, the fixed costs on machinery become sunk costs so if there are sunk costs in the market, they impede the first assumption of no exit barriers. That 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 so be unable to compete with the incumbent firm. That 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 the problem could be governments providing equal access to knowledge and technology, as well as financial resources for the same.<ref>Essentials of Economics, John Sloman (third edition) {{ISBN|0-273-68382-9}}</ref>

Its fundamental features are low [[barriers to entry]] and [[barriers to exit|exit]]; in theory, a perfectly contestable market would have no barriers to entry or exit ("frictionless reversible entry" in economist [[William A. Brock|William Brock]]'s terms).<ref name="Brock1055"/> Contestable markets are characterized by "hit and run" competition; if a [[theory of the firm|firm]] in a contestable market raises its prices so as to begin to earn [[excess profit]]s, potential rivals will enter the market, hoping to exploit the high price 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 that, even a single-firm market can show highly competitive behavior.<ref>Brock, 1983. p.1063, quoting Baumol, 1982: "This means that... an incumbent, even if he can threaten retaliation after entry, dare not offer profit-making opportunities to potential entrants because an entering firm can hit and run, gathering in the available profits and departing when the going gets rough."</ref>

A concise theoretical statement of contestable markets with an illustrative graph is at Economics Online.<ref name="EO" />