Contestable market
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.[1]
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 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.[2]
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.[3] 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.[4] 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.[4]
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]
See also
Notes
- ^ a b c Brock, 1983. p.1055.
- ^ 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."
- ^ Brock, 1983. p. 1057. "Some readers may feel that perfect contestability is an idealized notion of purely academic interest..."
- ^ a b Martin, 2000. p. 43.
- ^ For example, Greenspan, 1998.
- ^ Brock, 1983. p. 1064. "Baumol et al.'s plea for removal of artificial barriers to entry and exit is to be applauded... I am more skeptical about their conclusions that occasionally it is good public policy to restrict entry and competition."
References
- William J. Baumol, John C. Panzar, & Robert D. Willig (1982). Contestable Markets and the Theory of Industry Structure.
- William A. Brock (1983). "Contestable Markets and the Theory of Industry Structure: A Review Article". The Journal of Political Economy, v. 91, no. 6, pp. 1055-1066.
- John C. Panzar (1987). "Competition and efficiency," The New Palgrave: A Dictionary of Economics, v. 1, pp. 543-44.
- George J. Stigler (1987). "Competition," The New Palgrave: A Dictionary of Economics, v. 1, pp. 531-46.
- Antitrust by Alan Greenspan (arguing against the existence of anti-trust laws based on theory that government is solely responsible for coercive monopoly)
- Stephen Martin (2000). The Theory of Contestable Markets.