Contestable market
Topic: Market Structures, Market Failure and Competition · NCERT: Beyond NCERT
Meaning
A contestable market is one where firms can enter and leave freely and at no cost. William Baumol, John Panzar and Robert Willig set out the idea in 1982. The key idea is that the threat of entry disciplines the firms already in the market (the incumbents). Suppose they raise prices. A new firm can then enter, undercut them and leave without loss. So even a market with only one or a few firms may be pushed into competitive pricing. What weakens contestability is sunk costs: money spent on entering that cannot be recovered on exit.
Example
Indian aviation is contestable to some extent, because an airline can start flying a new route when fares there get high. But scarce airport slots work like sunk costs and entry barriers. They make it harder for a newcomer to enter and exit easily, so the market is less contestable.
Don't confuse with
- Perfect competition: needs very many small firms. A contestable market can have very few firms, because the discipline comes from potential entrants, not from existing rivals.
Related concepts
- Monopolistic competition
- Oligopoly
- Duopoly
- Kinked demand curve
- Price leadership
- Limit pricing
- Collusion
- Cartel