4.1.5.9 Contestable and non-contestable markets Quiz: AQA Economics, Unit 1

The 20 questions

1. A contestable market is one where:

   • Entry is blocked by high sunk costs and patents
   • Entry and exit are easy, so firms face the threat of competition even if few firms operate
   • Only one firm can ever supply the market
   • Firms control prices without any threat from rivals

2. Sunk costs are:

   • Costs that fall as output rises
   • Fixed costs that can be sold at full value on exit
   • Payments to suppliers made after a contract ends, which the firm must settle in full even when it no longer trades in the market
   • Costs that cannot be recovered if a firm leaves the market

3. Hit-and-run competition involves:

   • Firms competing only through advertising campaigns
   • Entering a market to take advantage of high profits and leaving quickly if prices fall
   • Firms merging to avoid competition in the long run
   • Firms raising prices and staying in the market permanently

4. Which market is most likely to be contestable?

   • A market requiring large investments in fixed plant that cannot be resold
   • A market with low sunk costs, where firms can enter and leave quickly
   • A market protected by patents for twenty years
   • A market dominated by one firm holding exclusive government licences

5. Why does contestability matter for market performance?

   • It removes the need for any firm to consider rivals
   • It means only perfectly competitive markets can be efficient
   • It guarantees abnormal profits for incumbents in every market
   • The threat of entry can discipline incumbents, keeping prices competitive even with few firms

6. A firm has sunk costs of £2 million and its assets have no resale value. If it exits the market, its loss is:

   • 1 million, half the sunk costs
   • 0, since all costs can be recovered on exit
   • £2 million, since sunk costs are not recovered on exit
   • 2 million plus its annual profits

7. An airline route has few firms but low sunk costs, because planes can be leased and moved easily. Which best describes the route?

   • Monopolistic, since each airline offers a different service
   • Highly contestable, so incumbents may keep fares low to deter entry
   • Perfectly competitive, since all airlines charge identical fares on every route
   • Non-contestable, because the number of firms is small

8. Which factor most reduces contestability?

   • Large numbers of small firms with identical costs, so that each firm is too small to affect the market and no firm can keep prices high
   • High sunk costs and legal or technical barriers to entry
   • Free entry and exit with easily resold assets
   • Low set-up costs that let any firm enter the market cheaply, so that incumbents face many new rivals in each year of trading

9. Why might a monopolist in a contestable market keep its price below the profit-maximising level?

   • It has no costs, so it charges as low as possible
   • Contestability forces the monopolist to match marginal cost exactly
   • The threat of hit-and-run entry constrains its price, so it sets lower prices to deter entrants
   • It is constrained by the rule that contestable markets require zero-profit pricing

10. Which statement best evaluates the claim that contestability alone is enough to ensure efficient outcomes?

    • Contestability guarantees efficiency in every market
    • Contestability helps, but sunk costs and information gaps in real markets can still limit entry, so efficiency is not guaranteed
    • Contestability only matters for firms in perfect competition
    • Contestability is irrelevant once a firm has a large market share

11. Non-contestable markets are typically characterised by:

    • High sunk costs, which deter entry and leave incumbents with market power
    • Zero fixed costs for all firms in the market
    • Free entry and exit with no barriers at all
    • Low sunk costs and easy resale of assets, which allow firms to enter and leave the market without losing much when conditions change

12. A firm invests in a specialised factory with no resale value. Why does this reduce contestability?

    • The investment makes the market perfectly competitive
    • The investment is sunk, so a potential entrant risks losing it if the market turns against them
    • Specialised factories are always bought by rivals at full price
    • The investment reduces fixed costs and attracts new firms

13. Which of the following is the best example of a sunk cost?

    • A lease on delivery vans that can be returned without penalty
    • Electricity bills paid only for the energy actually used
    • The rent on a warehouse that can be sublet at full value
    • Spending £500,000 on an advertising campaign that cannot be recovered

14. Hit-and-run competition is most likely when:

    • Patent protection blocks any new entrant for decades
    • The incumbent can cut prices immediately and at no cost
    • Entry costs are high and sunk investment is large
    • Entry costs are low and the incumbent cannot respond quickly to a new entrant

15. A monopolist expects that a new entrant with low sunk costs could leave quickly. This is an example of:

    • Predatory pricing against the entrant
    • Potential competition constraining the monopolist's behaviour
    • Price discrimination by the monopolist
    • Actual competition from an existing rival in the market

16. Contestability is best described as a property of:

    • The government's regulatory body
    • The personal skills of the firm's managers
    • The market, relating to the ease of entry and exit
    • An individual firm's marketing strategy

17. Why might a contestable market still have a small number of firms?

    • Contestable markets are always perfectly competitive in every respect, so the firms in such markets have identical costs
    • Contestable markets always have many small firms by law
    • Scale economies may keep the number of firms small, while the threat of entry keeps them competitive
    • Concentration is impossible when entry is free

18. Which action by an incumbent is most likely to deter entry in a contestable market?

    • Keeping prices close to average cost so that entry is not attractive
    • Reducing product quality to cut costs
    • Stopping all investment in capacity
    • Raising prices sharply to attract entrants

19. Which is an example of a barrier that makes a market non-contestable?

    • Low set-up costs for new service providers
    • Exclusive access to a key resource, such as an essential mineral deposit
    • Free public information on costs and prices
    • Freedom to resell all capital equipment at full value

20. Explain why sunk costs matter for hit-and-run competition.

    • Low sunk costs let entrants leave without large losses, so they are willing to enter when profits are high
    • Sunk costs mean entrants can always recover their investment on exit, so hit-and-run entry carries no risk of loss at any time
    • High sunk costs make entry easier because entrants share the risk of their investment with the other firms that have also committed
    • Sunk costs are irrelevant because firms never leave a market once they have entered

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