Contestable Market: Definition & Theory

Instructor: Brianna Whiting

Brianna has a masters of education in educational leadership, a DBA business management, and a BS in animal science.

In this lesson we will learn about contestable market. We will explore the theory and define important characteristics. The lesson will conclude with a summary and a quiz.

A First Look at Contestable Market

Meet Gabby! Gabby is a recent college graduate. Over the course of several months, Gabby has diligently applied to job after job in hopes of putting her degree to use. After countless rejections, it became obvious to Gabby that the best idea for her was to start her own business. By owning her own business she could utilize her newly acquired knowledge in a way that she sees fit. She could have control over her own ideas and decisions and run her business the way she feels would be the most successful. However, before Gabby jumps in, there are a few conditions that must be met in the market where she hopes to establish a business. As a new business owner, Gabby wants to enter a market where she has the freedom to operate without any barriers. She also wants to make sure that the money she invests in her company can be recouped at a later date. And, she wants to make sure she stays in the loop with all of the new technology and information that pertains to the industry she will be part of. What Gabby is looking for is a contestable market.

Contestable Market Further Defined

From our example, you may have gathered some of the important characteristics of a contestable market. In this section we will define this term more fully. First of all, a contestable market is derived from a theory proposed by William J. Baumol. Baumol suggests that even in the smallest of markets, those firms involved will remain competitive and therefore deter new firms from trying to enter. In a contestable market, there are no barriers to entry or exit, making it easy for any firm to freely come and go as they like.


While freedom to enter and exit is one characteristic of a contestable market, there are a few more that are equally important. In order to have a contestable market, there has to be low sunk costs. A sunk cost is a cost that a business incurs and cannot recover by any means. A great example of this is Gabby, our future business owner. Let's say Gabby pays $300,000 for a contractor to build her a brand new building. However, after construction takes place, the contractor has used all $300,000 but the building is not complete. This becomes a sunk cost, because Gabby will not get that money back. The only thing Gabby can do now is decide to pay more money in hopes of finishing her building or walking away altogether.

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