Airline Industry and Contestability Project What is a contestable marke

Airline Industry and Contestability Project What is a contestable market? In a contestable market, there are one or a number of firms which profit maximise. In other words the number of firms is irrelevant. The key assumption to make here is that barriers to entry to the industry are relatively low, as is the cost to exit the industry. The existence of potential entrants into the industry will tend to keep profits to their normal level even in the short run, because existing firms will want to deter new entrants from coming into the market. Contestable markets are both productively and allocatively efficient and are likely to be efficient in the short run as well. The theory regarding the type of profit made in a contestable market is this. Abnormal profit can only be made in the short run, only normal profit will be made in the long run. The reason being is that when firm try to profit maximises in the short run then this will attract new entrants into the market to take some of this profit away from the existing firm. As more competition is attracted then the new prices will force the prices and the profit down. This is the reason why it is only possible to make normal profit in the long run. The threat of potential entrants into the industry means that existing firms will behave competitively, even if the firm is a monopoly. The key assumption of a contestable market is that it gives the firms the ability to enter and exit the market. It is natural to assume that a monopoly is going to have high barriers to entry, but theory suggests that there is a large dependence on the cost to exit the industry rather than enter it. The cost of exiting and Industry is often termed as sunk costs. These are the costs that a firm can't recover when they decide to exit the industry. An example of a sunk cost would be money spent on advertising, because you cannot recover the money you spent on advertising. If sunk costs are low or virtually nothing then it is correct to assume that a firm is operating in a contestable market. The lower the sunk cost the greater the contestability of the market. The ease at which a firm can enter and exit a market will leave it vulnerable to 'Hit and Run' competition. If there is abnormal profit in an industry then newcomers will enter the market, take their share of the excess profit and exit the... ...ity of service. In a less contestable market firms are under less pressure to produce a service of the highest quality. Recent mergers involving Easyjet and Ryanair have meant that the industry is being dominated by two big firms. This is an example of a Contestable market, because there is less competition and these larger firms will benefit from economies of scale such as brand loyalty and these firms will have more slots for taking off or landing, which reduces the amount of competitors that can enter. The reason why it may be contestable is that in the industry there are lots of profits to be made. An increase in Ryanair profits would attract "hit and run" competition. Another reason is that Ryanair was able to purchase a Boeing 747 at a significant discount. This means that there will be low sunk costs as these planes could be sold off if you decide to exit the industry. To conclude it can be said that the low cost airline industry is seen as contestable, because of the east to set up, excess profits, but recent news show that it is more becoming less and less contestable with mergers and few firms producing at low cost and really dominating the industry.