Competition and Contestability

• Competition brings benefits to consumers such as lower prices, increased choice, and improved quality.
• In the short run, competition leads to lower prices for consumers as firms try to stay competitive.
• Competition also results in increased choice and variety of products in the market.
• In the long run, competition leads to allocative and productive efficiency.
• Creative destruction, driven by competition, leads to innovation and the replacement of outdated firms and products.
• Contestability is about the threat of new competition, while competition is about rivalry between existing firms.

Competition in markets brings various benefits to consumers, both in the short run and the long run. In the short run, competition leads to lower prices, increased choice, and improved quality of products. In the long run, competition promotes efficiency by achieving allocative and productive efficiency. It also drives innovation and the replacement of outdated firms and products through a process called creative destruction. Contestability, on the other hand, focuses on the threat of new competition entering the market. A contestable market is one where existing firms are influenced by this threat, while a non-contestable market lacks such a threat. Sunk costs and barriers to entry play a crucial role in determining the level of contestability. Higher barriers to entry reduce the threat of competition. The introduction of contestability in a monopolistic market can lead to lower prices, higher output, and improved efficiency. The level of contestability determines the extent of these outcomes. Therefore, when evaluating market structures, it is important to consider not only the level of competition but also the level of contestability.