Contestable markets

Contestable markets are a key concept in A-Level Economics, particularly within the OCR specification. A contestable market is one where there are low barriers to entry and exit, meaning new firms can enter the market easily and existing firms can leave without significant cost. This theory, developed by William Baumol, challenges traditional views of market structure by focusing on the threat of competition rather than the number of firms. In a perfectly contestable market, even a monopoly can be forced to behave competitively if there is a credible threat of new entrants (hit-and-run competition). Understanding contestable markets helps explain why some industries with few firms still offer low prices and high innovation, while others with many firms may not.

This topic is crucial for evaluating real-world markets, such as low-cost airlines, internet services, or taxi apps like Uber. It connects to broader themes like market failure, regulation, and competition policy. For OCR A-Level, you need to analyse how contestability affects pricing, profits, efficiency, and innovation. You should also be able to discuss the role of sunk costs, economies of scale, and legal barriers in determining contestability. Mastery of this concept allows you to critically assess government interventions, such as deregulation or promoting competition, and to evaluate whether markets are truly competitive or just potentially so.

Contestable markets theory is a powerful tool for exam essays, especially when evaluating the effectiveness of competition policy. It shifts the focus from static market structures (perfect competition, monopoly) to dynamic processes. By understanding contestability, you can argue that a monopoly might be more efficient than a competitive market if it faces the threat of entry. This nuanced view is highly valued in A-Level exams, as it demonstrates higher-order thinking. Make sure you can apply the theory to specific industries and use real-world examples to support your arguments.