According to economics concept, a contestable market refers to a market in which there are only a few companies that behave

in a competitive due to the threat of new entrants. William J Blauners theory explains that contestable markets exist where an entrant has access to all production techniques available to the incumbents, is not prohibited from wooing the incumbents customers, and entry decisions can be reversed without cost. In other words, contestable markets refers to a market place which have few sellers or maybe just one seller, where the seller is offering competitive prices even though there isnt any competition in the market. Monopoly refers to the market where there is only one seller and oligopoly refers to the market where there are not just more than one, but few sellers (fewer than in perfect competition). According to the contestable market theory, actual competition is not required to reduce monopoly inefficiencies, only the threat of competition. The contestable market theory also assumes that that even in a monopoly or oligopoly, the existing companies will behave competitively when there is a lack of barriers, such as government regulation and high entry costs, to prevent new companies from entering the market. In other words, in a contestable market the number of firms is not so important. It is important for the threat of competition to be sufficient to keep prices low and prevent abuse of monopoly power. A market is perfectly contestable if there are no entry or exit barriers, no sunk costs and there is access to the same level of technology (to incumbent firms and new entrants). Absence of sunk cost is the key requirement for a contestable market.

Sunk costs act as a barrier to contestability. These are costs that have been committed by a business cannot be recovered once a firm has entered the industry. When sunk costs are high, a market is more likely to produce a price and output similar to monopoly (with the risk of allocative inefficiency / market failure that follows on from this). Firms operating in markets without large sunk costs of entry will not earn large profits. There are some implications of contestable market theory. The number of firms in an industry is irrelevant in terms of economic efficiency. Abnormal profits attract new entrants driving down prices and ensuring economic efficiency. All markets (excluding natural monopoly) can be efficient so long as they are contestable. The market also shifts the emphasis of government competition policy away from number of firms towards reducing barriers to entry in an industry. Potential competition may be more important for economic efficiency than actual competition Figure 1 Monopoly profits and Deadweight welfare loss

In figure 1, the green area represents Supernormal Profit, which is equal to (ARAC) Q. The pink area represents the Deadweight welfare loss i.e. the combined

loss of producer and consumer surplus as compared to competitive market. From the diagram, it is understood that higher price and lower output than under Perfect Competition leads to a decline in consumer surplus and a deadweight welfare loss. A monopoly is allocatively inefficient because in monopoly the price is greater than MC. In a competitive market the price would be lower and more consumers would benefit. A monopoly is productively inefficient because it is not the lowest point on the AC curve. Also a monopoly has less incentive to cut costs because it doesn't face competition from other firms. Hence the AC curve is higher than it should be. A Monopolist makes Supernormal Profit Qm * (AR AC) and this causes unequal distribution of income. A monopoly may use its market power and pay lower prices to its suppliers. E.g. Supermarkets have been criticized for paying low prices to farmers. Many countries have used government intervention to make markets more contestable in recent years - through competition policy One of the main approaches is de-regulation - I.e. markets opened to competition by reducing statutory (legal) barriers to entry (examples include the main utilities, telecommunications and postal services). Tougher competition laws acting against predatory behavior by existing firms in a market / tougher rules against cartels. From postal services, to telecommunications and the suppliers of electricity and gas, many markets have become more contestable in recent years. This affects the conduct and behaviour of rival firms within each market. MTNL, BSES, GAS, TELECOM SERIVCE PROVIDERS, ISD AND STD Another approach is the changing nature of technology, which states that technological progress, has brought down the high entry costs in some markets (an increase in capital mobility). For e.g. Desktop publishing for magazines, ecommerce, where there is- emergence of new players in travel and online bookselling, household utilities such as new entrants able to supply gas and electricity and bill households and business users at Lower cost. For e.g. BSES, Airtel, Aircel, CNG. In economics, in contestable markets Hit-and-run tactics describe a firm that enters a market to take advantage of abnormal profits and then leaves. When entry and exit costs are low firms may engage in hit and run tactics. This means that if an industry is making supernormal profits then a firm can enter and take advantage of high prices. They might enter the market for a short period when high profits are being made and withdraw if prices fall and the industry is no longer profitable. Hit-and-run entry is not possible where products are physically identical but bear different brand names. For e.g. aspirin. As stated by Farrell (1986), if varieties produced by entrants and incumbents are identical but buyers are uncertain about the quality of entrants products, buyers will be reluctant to interact with the market. Therefore in a contestable market a firm should be satisfied with normal profits otherwise it would encourage hit and run tactics.

A good case study of deregulation and contestability (or lack of it) is the airline industry. Until the early 1990s, the European air transport industry was highly regulated, with governments controlling routes. National routes were often licensed to the national airline and international routes to the two respective national airlines. Since 1993, the industry has been progressively deregulated and competition has increased, with a growing availability of discount fares. Now, within the EU, airlines are free to charge whatever they like, and any EU airline can fly on any route it wants, providing it can get the slots at the airports at either end. As in the USA, however, whilst increased competition has benefited passengers, many of the airlines have tried to make their routes less contestable by erecting entry barriers. Predatory pricing has occurred, as the established airlines have tried to drive out new competitors. What is more, the proliferation of fare categories has made it hard for consumers to compare prices, and established carriers highly publicised fares often have many restrictions, with most people having to pay considerably higher fares. As in the USA, code sharing and airline alliances have reduced competition. Finally, at busy airports, such as Heathrow, the shortage of check-in and boarding gates, runways and airspace has provided a major barrier to new entrants. Nevertheless, low-cost airlines, such as easyJet, Ryanair and FlyBE, have increasingly provided effective competition for the established national and short-haul international carriers, which have been forced to cut fares on routes where they directly compete. Low-cost airlines have been able to enter the market by using other airports, such as Stanstead and Luton in the case of London, and various regional airports throughout Europe. The question is whether the middle-sized national carriers, with relatively high fixed costs, will be able to survive the competition. The filing for bankruptcy and subsequent baling out of Swissair and Sabena (the Belgian airline) following the September 2001 attack on the World Trade Center in New York, illustrates the vulnerability of such airlines. It is likely that several of the medium-sized carriers will have to merge or be taken over by a big carrier. From this essay, it is clear that contestability is not a clear-cut issue; there are degrees of contestability, some markets having more capacity for new firms to enter. There are no perfectly contestable markets. The main thing that matters is the degree of competition / contestability and what matters is not so much competition within a market, but rather competition for a market, and also the threat of entry of new suppliers but this may not be enough to affect the behaviour of existing firms. Structural changes in costs in different industries can change the degree of contestability. Contestability may force existing firms away from profit-maximising behaviour (e.g. towards sales-revenue maximisation). The absence of competition in a market over a long period of time does not necessarily suggest a lack of contestability.

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