The Nature and Scope of Contestability Theory

Contes tability theory suggests that threat of entry may prevent monopolistic pricing e ven in a concentrated market because, if exit from the market is easy, monopolis tic pricing would induce hit and run entry. This paper shows that, despite easy exit, hit and run entry is unprofitable if incumbents' price responses are suffi ciently rapid. Only market data (not experimental) can reveal whetherresponses are sufficiently rapid; available evidence indicates they are. Another version o f contestability theory stresses threat of entry through long-term contracts. Th is threat, too, is shown to be unlikely to check monopolistic pricing. Copyright 1986 by Royal Economic Society.