Contestability in the Presence of an Alternate Market: An Experimental Examination

Abstract

Most earlier experimental tests of the contestable market hypothesis assume a zero opportunity cost of entry. This design feature makes interpretation of results in terms of entry behavior problematic. The experimental study that I report tests contestability with the addition of an alternative market that yields a positive profit with certainty. This safe haven operationalizes a positive opportunity cost of entry. Hit-and-run entry is observed in the experiments. Adjusted mean prices are not significantly different from the zero opportunity cost case. Two methodological questions are also examined. In one treatment, sellers' price offers are allowed only in $0.25 increments. The simplification of the sellers' decision space makes collusive arrangements more probable. Secondly, market outcomes using human subject buyers are compared with outcomes from experiments with computer-simulated demand. The disciplining effect of human subject buyers results in market prices that converge to competitive levels more quickly.