Volume 7, No. 3 (Fall 2004)
Contestability theory makes a case that the pricing behavior of a multi-product natural monopolist is disciplined by the threat of entrepreneurial entry. The contestability model employs three major concepts. These include (1) economies of scope in which joint production of a slate of products is less costly than if each product were to be produced by separate firms; (2) subadditivity, a formal demonstration that the single firm is the least costly means of satisfying a specific demand for a specific slate of products. But even in such a case, “benefits of competitive pricing” are thought to be achievable if: (a) prospective entrants are assured of the ability to recoup entry costs; and (b) the incumbent firm is induced by threat of entry to charge sustainable prices such that no profitable entry is possible. (3) Sustainability is attained if market demand is being fully satisfied and the monopolist is able to charge prices that fully cover the cost of production and offer no prospects of profitable entry.
