 | This article needs additional citations for verification .(April 2020) |
In economics, the theory of contestable markets, associated primarily with its 1982 proponent William J. Baumol, held that there are markets served by a small number of firms that are nevertheless characterized by competitive equilibrium (and therefore desirable welfare outcomes) because of the existence of potential short-term entrants. [1]
A perfectly contestable market has three main features:
A perfectly contestable market is not possible in real life. Instead, the degree of contestability of a market is talked about. 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. [2]
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. [3]
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). [1] Contestable markets are characterized by "hit and run" competition; if a firm in a contestable market raises its prices so as to begin to earn excess profits, 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. [4]
A concise theoretical statement of contestable markets with an illustrative graph is at Economics Online. [2]
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. [5] Baumol himself argued based on the theory for both deregulation in certain industries and for more regulation in others. [6]
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. [7] 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. [1] 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. [8] 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, but 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. [8]
Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics focuses on the study of individual markets, sectors, or industries as opposed to the national economy as whole, which is studied in macroeconomics.
A monopoly, as described by Irving Fisher, is a market with the "absence of competition", creating a situation where a specific person or enterprise is the only supplier of a particular thing. This contrasts with a monopsony which relates to a single entity's control of a market to purchase a good or service, and with oligopoly and duopoly which consists of a few sellers dominating a market. Monopolies are thus characterized by a lack of economic competition to produce the good or service, a lack of viable substitute goods, and the possibility of a high monopoly price well above the seller's marginal cost that leads to a high monopoly profit. The verb monopolise or monopolize refers to the process by which a company gains the ability to raise prices or exclude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the power to charge overly high prices, which is associated with a decrease in social surplus. Although monopolies may be big businesses, size is not a characteristic of a monopoly. A small business may still have the power to raise prices in a small industry.
Monopolistic competition is a type of imperfect competition such that there are many producers competing against each other, but selling products that are differentiated from one another and hence are not perfect substitutes. In monopolistic competition, a company takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other companies. If this happens in the presence of a coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the company maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereals, clothing, shoes, and service industries in large cities. The "founding father" of the theory of monopolistic competition is Edward Hastings Chamberlin, who wrote a pioneering book on the subject, Theory of Monopolistic Competition (1933). Joan Robinson published a book The Economics of Imperfect Competition with a comparable theme of distinguishing perfect from imperfect competition. Further work on monopolistic competition was undertaken by Dixit and Stiglitz who created the Dixit-Stiglitz model which has proved applicable used in the sub fields of international trade theory, macroeconomics and economic geography.
A natural monopoly is a monopoly in an industry in which high infrastructural costs and other barriers to entry relative to the size of the market give the largest supplier in an industry, often the first supplier in a market, an overwhelming advantage over potential competitors. Specifically, an industry is a natural monopoly if the total cost of one firm, producing the total output, is lower than the total cost of two or more firms producing the entire production. This frequently occurs in industries where capital costs predominate, creating large economies of scale about the size of the market; examples include public utilities such as water services, electricity, telecommunications, mail, etc. Due to resource scarcity, economies of scale, and scope of economic benefits. Therefore, the probability that a company that provides a single product and service or a company that jointly provides most products and services will form a company (monopoly) or a minimal number of companies (oligopoly) is very probable. Natural monopolies were recognized as potential sources of market failure as early as the 19th century; John Stuart Mill advocated government regulation to make them serve the public good.
An oligopoly is a market structure in which a market or industry is dominated by a small number of large sellers or producers. Oligopolies often result from the desire to maximize profits, leading to collusion between companies. This reduces competition, leading to higher prices for consumers and lower wages for employees.
In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In theoretical models where conditions of perfect competition hold, it has been demonstrated that a market will reach an equilibrium in which the quantity supplied for every product or service, including labor, equals the quantity demanded at the current price. This equilibrium would be a Pareto optimum.
In economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfil all the necessary conditions of a perfectly competitive market. Imperfect competition will cause market inefficiency when it happens, resulting in market failure. Imperfect competition is a term usually used to describe the seller's position, meaning that the level of competition between sellers falls far short of the level of competition in the market under ideal conditions.
Porter's Five Forces Framework is a method of analysing the operating environment of a competition of a business. It draws from industrial organization (IO) economics to derive five forces that determine the competitive intensity and, therefore, the attractiveness of an industry in terms of its profitability. An "unattractive" industry is one in which the effect of these five forces reduces overall profitability. The most unattractive industry would be one approaching "pure competition", in which available profits for all firms are driven to normal profit levels. The five-forces perspective is associated with its originator, Michael E. Porter of Harvard University. This framework was first published in Harvard Business Review in 1979.
Anti-competitive practices are business or government practices that prevent or reduce competition in a market. Antitrust laws differ among state and federal laws to ensure businesses do not engage in competitive practices that harm other, usually smaller, businesses or consumers. These laws are formed to promote healthy competition within a free market by limiting the abuse of monopoly power. Competition allows companies to compete in order for products and services to improve; promote innovation; and provide more choices for consumers. In order to obtain greater profits, some large enterprises take advantage of market power to hinder survival of new entrants. Anti-competitive behavior can undermine the efficiency and fairness of the market, leaving consumers with little choice to obtain a reasonable quality of service.
In theories of competition in economics, a barrier to entry, or an economic barrier to entry, is a fixed cost that must be incurred by a new entrant, regardless of production or sales activities, into a market that incumbents do not have or have not had to incur. Because barriers to entry protect incumbent firms and restrict competition in a market, they can contribute to distortionary prices and are therefore most important when discussing antitrust policy. Barriers to entry often cause or aid the existence of monopolies and oligopolies, or give companies market power. Barriers of entry also have an importance in industries. First of all it is important to identify that some exist naturally, such as brand loyalty. Governments can also create barriers to entry to meet consumer protection laws, protecting the public. In other cases it can also be due to inherent scarcity of public resources needed to enter a market.
Monopoly profit is an inflated level of profit due to the monopolistic practices of an enterprise.
Predatory pricing is a pricing strategy, using the method of undercutting on a larger scale, where a dominant firm in an industry will deliberately reduce the prices of a product or service to loss-making levels in the short-term. The aim is that existing or potential competitors within the industry will be forced to leave the market, as they are unable to effectively compete with the dominant firm without making a loss. Once competition has been eliminated, the dominant firm now having a majority share of the market can raise its prices to monopoly levels in the long-term to recoup its losses.
In economics, market power refers to the ability of a firm to influence the price at which it sells a product or service by manipulating either the supply or demand of the product or service to increase economic profit. In other words, market power occurs if a firm does not face a perfectly elastic demand curve and can set its price (P) above marginal cost (MC) without losing revenue. This indicates that the magnitude of market power is associated with the gap between P and MC at a firm's profit maximising level of output. Such propensities contradict perfectly competitive markets, where market participants have no market power, P = MC and firms earn zero economic profit. Market participants in perfectly competitive markets are consequently referred to as 'price takers', whereas market participants that exhibit market power are referred to as 'price makers' or 'price setters'.
In economics, free entry is a condition in which firms can freely enter the market for an economic good by establishing production and beginning to sell the product. The assumption of free entry implies that if there are firms earning excessively high profits in a given industry, new firms that also seek a high profit are likely to start to produce or change into a production of the same good to join the market. In such a case there are no barriers preventing a start-up firm from competing. Where an opportunity of a profit arises we assume that there will also be firms entering the market for the certain good and compete for it. In most markets this condition is present only in the long run.
In the theories of competition in economics, strategic entry deterrence is when an existing firm within a market acts in a manner to discourage the entry of new potential firms to the market. These actions create greater barriers to entry for firms seeking entrance to the market and ensure that incumbent firms retain a large portion of market share or market power. Deterring strategies, might include an excess capacity, limit pricing, predatory pricing, predatory acquisition and switching costs. Although in the short run, entry deterring strategies might lead to a firm operating inefficiently, in the long run the firm will have a stronger holder over market conditions.
Market structure, in economics, depicts how firms are differentiated and categorised based on the types of goods they sell (homogeneous/heterogeneous) and how their operations are affected by external factors and elements. Market structure makes it easier to understand the characteristics of diverse markets.
In economic competition theory, the zero-profit condition is the condition that occurs when an industry or type of business has an extremely low (near-zero) cost of entry to or exit from the industry. In this situation, some firms not already in the industry tend to join the industry if they calculate that they will make a positive economic profit. More and more firms will enter until the economic profit per firm has been driven down to zero by competition. Conversely, if firms are making negative economic profit, enough firms will exit the industry until economic profit per firm has risen to zero.
In economics, competition is a scenario where different economic firms are in contention to obtain goods that are limited by varying the elements of the marketing mix: price, product, promotion and place. In classical economic thought, competition causes commercial firms to develop new products, services and technologies, which would give consumers greater selection and better products. The greater the selection of a good is in the market, prices are typically lower for the products, compared to what the price would be if there was no competition (monopoly) or little competition (oligopoly).
In economics, barriers to exit are obstacles in the path of a firm that wants to leave a given market or industrial sector. These obstacles often have associated costs, prohibiting the firm from leaving the market. If the barriers of exit are significant, a firm may be forced to continue competing in a market. This forced stay in the market occurs when the costs of leaving a market are higher than costs incurred by continuing in the market. Sometimes, when firms operate at low profit or at loss, they still choose to compete with others. Major factors of this decision making is high barriers to exit.
A profit is the difference between the revenue that an economic entity has received from its outputs and the opportunity costs of its inputs. It equals to total revenue minus total cost, including both explicit and implicit costs.