Firms in a perfectly contestable market will be forced to operate as efficiently as possible and to charge prices as low as long-run financial survival permits. Why?

Question

What will be an ideal response?

Answer 1

The freedom of entry eliminates any excess economic profits, so in this respect contestable markets resemble perfectly competitive markets. Excess profits prompt new firms to enter the market, expand the industry’s outputs, and drive down the prices of its products to the point at which no firm earns any excess profit. To avoid this outcome, established firms must expand output to a level that precludes excess profit. Second, inefficient enterprises cannot survive in a perfectly contestable industry because cost inefficiencies invite replacement of the existing firms by entrants that can provide the same outputs at lower cost and lower prices. Only firms operating at the lowest possible cost can survive.