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In economics, a contestable market is a market served by only one firm, but with mandated "competitive" pricing, so as to escond the monopoly held by said firm on said market. Its fundamental feature is low barriers to entry and exit; a perfectly contestable market would have no barriers to entry or exit. Contestable markets are characteristed by 'hit and run' entry. If a firm in a market with no entry or exit barriers raises its prices above marginal cost and begins to earn abnormal profits, potential rivals will enter the market to take advantage of these profits. When the incumbent firm(s) respond by returning prices to levels consistent with normal profits the new firms will exit. In this manner even a single-firm market can show highly competitive behaviour.
The theory of contestable markets has been used to argue for weaker application of antitrust laws as simply observing a highly concentrated or monopoly market does not mean that the firm is harming consumers by earning super-normal profits. The applicability of the theory to real world situations has been questioned, however, particularly as there are very few markets which are completely free of sunk costs and entry and exit barriers.
Low cost airlines are commonly referred to as an example of a contestable market. Entrants have the possibility of leasing aircraft and should be able to respond to high profits by quickly entering and exiting. In practice there may be barriers to entry and exit in the market associated with terminal leases and availability and predatory pricing by incumbents, signalled through built-in overcapacity.
Contestable markets do NOT have to only have one firm; The assumptions however are correct, but the market it expected to have low sunk costs, in order to enable effective 'hit and run' strategy!
