Main findings, recent examples and diagrams

• Theory of contestability in markets has attempted to displace the mainstream field of competition – But has flaws in its assumptions, two of which are conflicting:

1. Entry is free, without limit
2. Entry is absolute
3. Entry is perfectly reversible

• The theory (developed by Baumol, Panzar and Willig) decided to take a new approach of focussing on the possibility of free entry into markets rather than on the barriers to argue that market dominance and high concentration have little effect to the inefficient results of monopoly/oligopoly markets
• There is the argument that “perfect contestability” will nullify any negative effects of a monopoly, hence naming them “an innocent phenomenon” where an “efficient competitive outcome would always be achieved” – an attempt to cut back to minimal antitrust policies in the market (regulations for firms to promote competition):

• However, such conditions needed for contestability theory are counter-intuitively restrictive, being too strict and not observed in any actual markets, other than those few that were already effectively competitive where the conditions would be irrelevant to their performance e.g. in the agriculture market:

• In conclusion, markets are not able to to be truly contestable. This theory is inconsistent with the reality of market power and the need for efficient policy treatments for them:
• Assumptions 1 and 2 counter each other as entry cannot be both trivial (incumbent sees newcomer has no force) and total (newcomer can oust the incumbent firm completely and immediately)
• It also fails to recognise the reality of consumer and producer behaviour, which make barriers to entry more widespread and threatening of an issue than assumed with contestability theory: from exogenous causes (e.g. technology) and endogenous causes (actions taken by incumbent firms specifically to make entry harder). A big example can be Coca Cola, where a new firm would find it particularly difficult to gain their customers out of inert or habitual consumer behaviour as well as dealing with their licensing deals with every fast-food chain and shelf space in supermarkets: