A contestable market is a type of market structure in which firms can enter and exit freely and costlessly, therefore making the incumbent firms vulnerable from hit-and-run entry. Due to the freedom of entry and exit there must be an insignificant level of sunk costs attached to competing in these types of market.
Below is a graphic to illustrate the main characteristics of a contestable market. For instance the firms that wish to engage in hit-and-run entry need to be classed as profit maximisers, otherwise the incentive to undercut the incumbent firms will not exist. Firms also need to have perfect information to be able to undertake successful hit-and-run entry. Finally the key factor is that firms need to be able to enter absolutely freely and exit absolutely costlessly.
