1. Objectives:
By the end of this section you should be able to:
1) State and explain the characteristics of a contestable market
2) Explain how markets can become more contestable
3) Explain using a diagram the implications of contestable market theory
4) Application to a transport industry

2.  Concept developed by Baumol in 1970’s
 Unpinned UK transport policy over past 30 years
 Not a market structure alongside the 4 others we have looked at
 The objective of contestability is to bring about the conditions of
a perfectly competitive market in any such market structure
All markets CAN be economically efficient if they are contestable
No perfect examples of a contestable market exist in reality
What matters is the THREAT of ENTRY of new suppliers – this
may be enough to change the behaviour of existing firms
Contestability may force firms away from profit maximising
behaviour to something else such as sales revenue maximisation

3. •Lack of barrier to entry and exit – this should be
government’s policy
•A market which is open to ‘hit and run competition’
•Absence of sunk costs (key characteristic)
•Lack of brand loyalty
•Lack of collusion/price fixing
•Perfect knowledge exists
•The number of firms in the market is not important/relevant
in terms of economic efficiency
•Only makes normal profit in the LR

4. De-regulation – reducing statutory barriers to
entry to liberalise a market i.e. Open skies
agreement March 2008
Tougher competition laws – acting against
predatory behaviours by existing firms and tough
rules against cartels
Changing nature of technology – this has
brought down entry costs in some market i.e. Low
cost airline industry

5. •The monopolist charges the
profit maximising price P
Price
MC
AC
P
•If the market is contestable then
it will be vulnerable to ‘hit and
run entry’
•A monopolist will try and avoid
this happening by setting price
equal to AC at P1 so that there
are no abnormal profits to attract
new firms
P1
D=AR
•Hence only normal profits are
made in the long run
•No one in the industry has an
advantage over anyone else
Q
Q1
Output
MR

6. Discuss the extent to which air passenger transport is a
contestable market. [20]

7. JUNE 2011
Discuss the extent to which the UK bus market is contestable.
[20]

8. DATA RESPONSE JUNE 2008
Cii)
Comment on the extent to which the rail freight
industry is contestable (4)
d)
Discuss the effects of increasing competition in the rail
freight on the economic efficiency of the freight transport
industry
(6)

9. January 2012 – Data Response
Discuss the extent to which air passenger transport is a
contestable market. [5]

12. •Availability of take-off and landing slots
•Necessity of entering a new route on a large enough
scale to achieve acceptable cost levels
•The costs of leasing new fleets of aircraft
•Securing an air operator’s licence from the EU
•Contracts with ground-handling companies
•Retaliatory behaviour by rivals i.e. Expansion in flight
frequency, cuts in fares
•Overcoming existing customer loyalty achieved by
companies who have exploited first-mover advantage
on specific routes

13. Analyse the characteristics of a contestable
market. [15]
Analyse the relationship between contestability
and efficiency within a market. [15]
JUNE 2011
Discuss the extent to which the UK bus market is
contestable. [20]
Discuss the extent to which air passenger
transport is a contestable market. [20]