A Level Economics AQA Practice Exam

What is a contestable market?

1. A market dominated by one firm

2. A market with significant government regulation

3. A market with easy entry and exit for firms

4. A market where firms engage in price discrimination

The correct answer is: A market with easy entry and exit for firms

A contestable market is characterized by the ease of entry and exit for firms. In such a market, there are no significant barriers that prevent new firms from entering or existing firms from leaving, which can influence the behavior of existing firms. This ability to enter and exit freely puts pressure on incumbent firms to keep prices competitive and provide high-quality products or services, as the threat of potential competition can discourage them from taking advantage of their current market position. In a contestable market, even if there is a single dominant firm at a particular time, the threat of new entrants ensures that this firm cannot behave like a monopolist. For instance, if a dominant firm attempts to raise prices, the threat of new firms entering the market and offering lower prices forces it to maintain competitive pricing. Therefore, the defining feature of a contestable market is indeed the low barriers to entry and exit, which fosters a competitive environment that benefits consumers. The other options do not encompass the essence of what defines a contestable market. A market dominated by one firm implies a monopoly, while significant government regulation suggests restrictions that may inhibit entry, contrary to the principles of contestability. Finally, while firms engaging in price discrimination can exist in various market structures, it does not relate directly to