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there are degrees of contestability
- a perfect contestable market has no sunk cost

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abnormal profits in the short run but only normal profit in the long run

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firms face threat of competition which puts pressure on the firms to be efficient

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market that existing firms only make NORMAL profit , it can't set a price higher than AC without attracting new entry owing to the absence of barriers to entry and sunk cost

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Possibility they make subnormal profit - induce them to exit the market

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The absence of exit costs- provides potential firms the incentive to enter the market

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sunk costs - costs that are already invested in an industry which cannot be recovered

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When incumbent firm/firms are making SUPERNORMAL PROFIT:

1️⃣Potential transient entrants will:
✅Enter market
✅Exploit the profit opportunity by >charging prices lower than those charged by incumbent firm/firms<

This will then lead to⬇️

2️⃣Incumbent firm/firms will:
✅Reduce their prices to levels lower than those charged by the transient entrants

Process continues until:
Prices fall to the levels which correspond to ❇️NORMAL PROFIT❇️
which causes:
➡️transient entrants leaving the market
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Prospect of hit-and-run competition from potential transient entrants will induce the incumbent firm/firms in market to behave in a way firms in a ✳️highly competitive market✳️
resulting in:

✅x-efficiency + productive efficiency
(hence they charge price lower than price charged if market was less/non-contestable)
✅Lower price= av.cost ▶️ normal profit in LR ▶️ equal distribution of income

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High barriers to entry - prevent potential firms from entering the market

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Barrier to entry- an obstacle which restricts potential firms from entering a market to compete

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Increasing access to same technology production of incumbent firm(s)

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Increase degree of contestability

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Granting more licenses to operate in the market

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a market where there is no barriers of entry

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Preventing key factor inputs from being controlled by incumbent firm(s)

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The lower the barriers to entry and exit costs in the market - the more contestable the market is

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Govt lower barriers to entry

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Govt policy - to increase degree of contestability (more towards PC)

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Exit cost do exist

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However, barriers to entry do exist

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Potential firms suffer no disadvantage:
- perceived product quality

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All firms have equal access to production technology

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Zero exit costs

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Yes (test)