ChainWhat it assumes · how to break it
Start
Barriers to entry fall, for example when deregulation lets new suppliers enter a market that was dominated by one firm.
1
As a result, new firms can enter, and leave, without large sunk costs, so the market becomes more contestable.
contestable market · sunk costs
contestable market · sunk costs
Assumes: Entry and exit costs really are low.
But: Incumbents may still have brand loyalty, economies of scale or control of distribution, so entry remains hard in practice.
2
This means new firms enter with different products and ways of selling, so consumers have more choice.
consumer choice · product differentiation
consumer choice · product differentiation
Assumes: Entrants actually come into the market.
But: If incumbents respond by limit pricing, entry may not happen, so choice grows little even though prices fall.
3
At the same time, competition pushes price down towards AC, so consumer surplus rises.
consumer surplus
consumer surplus
Assumes: Lower costs and prices are passed through to all customers.
But: Firms may offer low prices only to new customers while charging loyal customers more.
4
In addition, firms must keep quality and service high to stop customers switching to rivals.
quality · switching
quality · switching
Best link to attack
Assumes: Consumers compare offers and switch easily.
Assumes: Consumers compare offers and switch easily.
But: If products are complex, such as energy tariffs or phone contracts, many consumers stay with their existing supplier, so firms face little pressure on price or quality.
End
Consumers gain lower prices, more consumer surplus, more choice and better quality.
Evaluation chain
- E1However, the gain to consumers depends on whether they actually shop around and switch.
- E2Because comparing complex tariffs takes time and many consumers stay with their existing supplier out of inertia, firms can keep charging loyal customers more.
- E3As a result, the benefits of entry go mainly to active switchers, while loyal and less confident customers may pay more.
- E4So lower barriers raise consumer surplus and choice overall, but the gain is uneven and smaller where inertia is strong, which is one reason regulators sometimes step in to protect loyal customers.
Can you say this chain from memory?
Members can hide the links, test themselves and track which chains they have mastered.
Practise this chainMembers can hide the links, test themselves and track which chains they have mastered.
Questions this answers
- Assess the impact of lower barriers to entry on consumers.
- Explain how deregulation can increase consumer choice.
- Discuss whether consumers always benefit when new firms enter a market.
Diagram
Contestable market diagram: price falls from the profit-maximising level to where AR = AC and output rises, so the consumer surplus area under AR and above price grows.
Reverse and related
Higher barriers to entry → fewer suppliers, higher prices and less choice for consumers.