Contestable Markets and Business Growth: Barriers to Entry/Exit, Hit-and-Run Competition, Limit Pricing, Predatory Pricing, Mergers, Integration, Principal-Agent Problem

1. A perfectly contestable market requires

A high sunk costs and strong brand loyalty
B free entry and free exit with no sunk costs
C one firm protected by patents
D government ownership of all firms

2. A contestable market may have low prices even with only a few firms because

A potential entry can discipline existing firms
B firms are legally forced to make losses
C consumers cannot switch suppliers
D all firms must collude

3. A market is more contestable when

A barriers to entry and exit are low
B sunk costs are high
C advertising creates strong brand loyalty
D legal restrictions prevent entry

4. Hit-and-run competition occurs when firms

A enter a market temporarily to earn profit and leave before retaliation
B permanently merge with rivals
C agree to fix prices
D refuse to enter profitable markets

5. Hit-and-run entry is most likely when

A entry is easy and exit is cheap
B sunk costs are very high
C incumbent firms control essential resources
D consumers are locked into long contracts

6. Which is a barrier to entry?

A patent protection
B no sunk costs
C perfect information
D free access to distribution channels

7. Which is a barrier to exit?

A high cost of leaving a market due to specialised assets
B low fixed costs
C no redundancy payments
D easy resale of capital equipment

8. Sunk costs are

A costs that cannot be recovered once incurred
B costs that change directly with output
C costs that are always zero
D costs paid only by consumers

9. Which is the best example of a sunk cost?

A expenditure on a specialised machine with no resale value
B wages paid to temporary workers per unit
C raw material costs that vary with output
D rent that can be cancelled immediately without penalty

10. A market with high sunk costs is less contestable because

A potential entrants risk losing money if they fail and exit
B incumbent firms cannot produce output
C consumers become perfectly informed
D price automatically equals marginal cost

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

11. Limit pricing occurs when an incumbent firm

A sets a low price to discourage entry
B sets price at the highest possible monopoly level
C charges different prices to different consumers
D agrees with rivals to fix prices

12. Predatory pricing occurs when a firm

A temporarily sets very low prices to drive rivals out
B raises price because demand rises
C sets price equal to average cost forever
D charges different prices due to cost differences

13. Which is the main difference between limit pricing and predatory pricing?

A limit pricing deters entry; predatory pricing aims to force existing rivals out
B limit pricing always raises price; predatory pricing always raises price
C both are forms of government regulation
D predatory pricing is only used by perfectly competitive firms

14. Limit pricing is more likely to be credible when the incumbent firm

A has lower costs than potential entrants
B has higher costs than all entrants
C cannot expand output
D has no brand loyalty or scale advantage

15. Predatory pricing may be difficult to prove because

A low prices may also result from genuine efficiency or competition
B all low prices are automatically illegal
C firms never know their own costs
D consumers always lose from lower prices immediately

16. A firm may use excess capacity as a barrier to entry because it can

A quickly increase output and cut price if entry occurs
B reduce output to zero permanently
C stop producing and leave the market
D make demand perfectly elastic

17. Brand loyalty is a barrier to entry because

A new firms may need heavy advertising to attract customers
B it makes consumers buy only the cheapest product
C it removes the need for marketing
D it makes all goods homogeneous

18. Economies of scale create a barrier to entry because

A large incumbents may produce at lower average cost than small entrants
B entrants always have lower average costs
C small firms can always match large firms’ costs immediately
D average cost is unrelated to output scale

19. Ownership of a key raw material can be a barrier to entry because

A new firms may be unable to access essential inputs
B it reduces the incumbent’s market power
C it guarantees perfect competition
D it creates many identical producers

20. Network effects create barriers to entry when

A a product becomes more valuable as more people use it
B a product becomes less valuable as demand rises
C consumers are indifferent between all networks
D switching costs are zero

21. Switching costs reduce contestability because

A consumers may be reluctant to move from incumbent firms
B consumers change supplier instantly
C entrants need no customers
D firms cannot set prices

22. Which market is likely to be most contestable?

A online tutoring with low set-up costs and easy exit
B electricity grid ownership with huge sunk infrastructure costs
C patented drug production
D airport runway ownership in a major city

23. Which market is likely to be least contestable?

A local window cleaning
B handmade craft selling online
C natural gas pipeline network
D freelance graphic design

24. A firm in a contestable market may choose not to charge a monopoly price because

A high profits may attract new entrants
B consumers cannot observe prices
C entry is impossible
D sunk costs protect the incumbent

25. Contestability theory suggests that market performance depends heavily on

A threat of potential competition
B number of firms only
C government ownership only
D consumer income only

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

26. Organic/internal growth occurs when a firm

A expands using its own resources, such as opening new branches
B merges with another firm
C is taken over by a rival
D buys a supplier only

27. External growth occurs when a firm

A expands by merger or takeover
B increases output using existing capacity only
C trains workers internally only
D sells more without changing ownership

28. A merger occurs when

A two firms combine to form one larger firm
B one firm reduces output
C consumers switch brands
D government imposes a tariff

29. A takeover occurs when

A one firm gains control of another firm
B two firms agree never to sell goods
C a firm hires more workers internally
D a firm changes its logo

30. Horizontal integration occurs when firms combine

A at the same stage of production in the same industry
B at different stages of the same production process
C in completely unrelated industries
D only with consumers

31. Vertical integration occurs when firms combine

A at different stages of the same production process
B at the same stage of production
C in unrelated industries
D only with government departments

32. Backward vertical integration occurs when a firm

A takes over a supplier
B takes over a customer or retailer
C merges with a direct rival
D buys an unrelated business

33. Forward vertical integration occurs when a firm

A takes over a distributor or retailer
B takes over a raw material supplier
C merges with a direct rival
D exits the market

34. Conglomerate integration occurs when firms combine

A in unrelated industries
B at the same production stage
C as buyer and supplier in the same industry
D only to reduce wages

35. A car manufacturer buying a tyre producer is

A backward vertical integration
B forward vertical integration
C horizontal integration
D conglomerate integration

36. A car manufacturer buying a chain of car dealerships is

A forward vertical integration
B backward vertical integration
C horizontal integration
D diversification into unrelated markets

37. Two competing banks merge. This is

A horizontal integration
B backward vertical integration
C forward vertical integration
D conglomerate integration

38. A food producer buying a hotel chain is most likely

A conglomerate integration
B backward vertical integration
C horizontal integration
D forward vertical integration

39. Which is a possible benefit of horizontal integration?

A larger market share and economies of scale
B guaranteed lower prices for consumers
C no risk of monopoly power
D automatic perfect competition

40. Which is a possible disadvantage of horizontal integration?

A reduced competition and possible monopoly power
B loss of all economies of scale
C guaranteed lower average cost in every case
D automatic entry of many new firms

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

41. Which is a possible benefit of backward vertical integration?

A greater control over supplies and input costs
B less control over raw materials
C guaranteed lower demand
D immediate loss of market power

42. Which is a possible benefit of forward vertical integration?

A greater control over distribution and final consumers
B less access to customers
C fewer selling opportunities
D loss of all branding

43. Which is a possible benefit of conglomerate integration?

A risk spreading across different markets
B guaranteed productive efficiency
C no management problems
D complete removal of uncertainty

44. Which is a possible problem of conglomerate integration?

A managers may lack expertise in unrelated markets
B risk is always increased to infinity
C the firm must become smaller
D all products become identical

45. The principal-agent problem occurs when

A managers may pursue their own objectives rather than shareholders’ objectives
B shareholders always control every daily decision
C consumers become perfectly informed
D firms have no managers

46. Separation of ownership and control means

A shareholders own the firm but managers make many decisions
B consumers own the firm and workers buy products
C government owns every firm
D managers cannot make decisions

47. Managers may prefer growth over profit maximisation because growth may increase

A salary, prestige and job security
B shareholder dividends only
C consumer surplus necessarily
D allocative efficiency automatically

48. Which objective is most closely linked to managerial self-interest?

A sales growth or empire building
B profit maximisation for shareholders only
C price equal to marginal cost
D zero output

49. Which policy may reduce the principal-agent problem?

A performance-related pay linked to profit or share price
B giving managers no targets or monitoring
C preventing shareholders from voting
D hiding accounts from owners

50. Which chain is most accurate?

A low entry barriers and no sunk costs → hit-and-run entry possible → incumbents keep prices lower → market becomes more contestable
B high sunk costs → easy exit → more contestability → monopoly price guaranteed
C horizontal merger → more competitors → lower concentration ratio → perfect competition
D principal-agent problem → managers always maximise shareholder profit → no conflict

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

1. Answer: B

A wrong: high sunk costs and brand loyalty reduce contestability.
B correct: perfect contestability requires free entry, free exit and no sunk costs.
C wrong: patents create legal barriers to entry.
D wrong: government ownership does not define contestability.

2. Answer: A

A correct: even a few firms may keep prices low if they fear new entrants.
B wrong: firms are not legally forced to make losses.
C wrong: consumer switching difficulty reduces contestability.
D wrong: collusion reduces competition.

3. Answer: A

A correct: low entry and exit barriers make hit-and-run competition more possible.
B wrong: high sunk costs make exit costly.
C wrong: brand loyalty protects incumbents.
D wrong: legal restrictions reduce entry.

4. Answer: A

A correct: hit-and-run competition means firms enter, take profit, and leave before incumbents can react strongly.
B wrong: merging is external growth.
C wrong: price fixing is collusion.
D wrong: hit-and-run firms enter profitable markets.

5. Answer: A

A correct: easy entry and cheap exit make temporary entry possible.
B wrong: high sunk costs trap entrants.
C wrong: control of resources blocks entry.
D wrong: long contracts reduce consumer switching and contestability.

6. Answer: A

A correct: patent protection legally prevents rivals from entering/copying.
B wrong: no sunk costs make entry easier.
C wrong: perfect information supports contestability.
D wrong: free distribution access lowers barriers.

7. Answer: A

A correct: specialised assets with low resale value make leaving costly.
B wrong: low fixed costs reduce exit barriers.
C wrong: no redundancy payments reduce exit cost.
D wrong: easy resale reduces exit barriers.

8. Answer: A

A correct: sunk costs are unrecoverable costs once spent.
B wrong: output-changing costs are variable costs.
C wrong: sunk costs are not always zero.
D wrong: firms usually incur sunk costs, not consumers only.

9. Answer: A

A correct: a specialised machine with no resale value is unrecoverable if the firm exits.
B wrong: temporary wages vary with output and are avoidable.
C wrong: raw materials can often be reduced if output falls.
D wrong: cancellable rent is not sunk.

10. Answer: A

A correct: entrants fear losing unrecoverable costs if entry fails.
B wrong: incumbents can still produce.
C wrong: sunk costs do not make consumers perfectly informed.
D wrong: P = MC is not automatic.

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

11. Answer: A

A correct: limit pricing means setting a price low enough to discourage new entrants.
B wrong: highest monopoly price may attract entry.
C wrong: different consumer prices are price discrimination.
D wrong: agreement with rivals is collusion.

12. Answer: A

A correct: predatory pricing means temporarily setting very low prices to drive rivals out.
B wrong: raising price due to demand is normal pricing.
C wrong: AC pricing is break-even/normal-profit pricing.
D wrong: cost-based differences are not predatory pricing.

13. Answer: A

A correct: limit pricing discourages entry; predatory pricing targets existing rivals.
B wrong: both involve low prices, not raised prices.
C wrong: both are firm strategies, not government regulation.
D wrong: perfectly competitive firms lack power to use predatory pricing effectively.

14. Answer: A

A correct: lower costs allow the incumbent to sustain a low price profitably.
B wrong: higher costs make low prices less credible.
C wrong: inability to expand output weakens the threat.
D wrong: no advantage makes entry easier.

15. Answer: A

A correct: low prices can reflect efficiency or tough competition, so intent is hard to prove.
B wrong: not all low prices are illegal.
C wrong: firms usually know their own costs.
D wrong: consumers often benefit from lower prices in the short run.

16. Answer: A

A correct: excess capacity lets the incumbent flood the market and lower price if entry occurs.
B wrong: reducing output to zero does not deter entrants.
C wrong: exit is not the threat.
D wrong: excess capacity does not make demand perfectly elastic.

17. Answer: A

A correct: entrants must spend heavily to overcome existing customer loyalty.
B wrong: brand loyalty makes consumers less price-sensitive, not only cheapest-focused.
C wrong: it increases the need for marketing.
D wrong: it differentiates products.

18. Answer: A

A correct: incumbents with large scale may have lower average costs than small entrants.
B wrong: entrants often have higher average costs.
C wrong: small firms cannot always match scale economies.
D wrong: average cost is strongly related to scale.

19. Answer: A

A correct: control of essential inputs can prevent rivals producing.
B wrong: it increases market power.
C wrong: it weakens competition.
D wrong: it does not create many producers.

20. Answer: A

A correct: network effects mean more users make the product/service more valuable, protecting incumbents.
B wrong: network effects increase value as use rises.
C wrong: users often prefer larger networks.
D wrong: switching costs may be high.

21. Answer: A

A correct: switching costs make consumers less willing to move to entrants.
B wrong: instant switching increases contestability.
C wrong: entrants need customers.
D wrong: firms can still set prices.

22. Answer: A

A correct: online tutoring often has low entry costs, low sunk costs and easy exit.
B wrong: electricity grids have huge sunk infrastructure costs.
C wrong: patents block entry.
D wrong: airport runways require massive sunk costs and permissions.

23. Answer: C

A wrong: window cleaning usually has low entry costs.
B wrong: online craft selling is relatively easy to enter.
C correct: natural gas pipelines involve huge sunk infrastructure and entry barriers.
D wrong: freelance design has relatively low entry barriers.

24. Answer: A

A correct: monopoly pricing creates supernormal profit, attracting hit-and-run entrants.
B wrong: consumers usually observe prices.
C wrong: entry is possible in contestable markets.
D wrong: sunk costs reduce contestability, not the contestable-market discipline.

25. Answer: A

A correct: contestability theory stresses potential competition, not just actual number of firms.
B wrong: number of firms alone is not enough.
C wrong: government ownership is unrelated.
D wrong: consumer income is not the central factor.

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

26. Answer: A

A correct: internal growth means expansion from within, such as more branches or higher output.
B wrong: merger is external growth.
C wrong: takeover is external growth.
D wrong: buying a supplier is external growth through vertical integration.

27. Answer: A

A correct: external growth happens through merger or takeover.
B wrong: using existing capacity is internal expansion.
C wrong: training workers is internal improvement.
D wrong: selling more without ownership change is internal growth.

28. Answer: A

A correct: a merger occurs when two firms combine into one larger firm.
B wrong: output reduction is not a merger.
C wrong: consumer switching is demand behaviour.
D wrong: tariff is trade policy.

29. Answer: A

A correct: takeover means one firm gains control of another.
B wrong: agreeing not to sell is not takeover.
C wrong: hiring workers is internal expansion.
D wrong: logo change is rebranding.

30. Answer: A

A correct: horizontal integration is between firms at the same production stage in the same industry.
B wrong: different stages mean vertical integration.
C wrong: unrelated industries mean conglomerate integration.
D wrong: consumers are not firms combining.

31. Answer: A

A correct: vertical integration is between firms at different stages of the same production chain.
B wrong: same stage is horizontal integration.
C wrong: unrelated industries are conglomerate integration.
D wrong: government departments are not the definition.

32. Answer: A

A correct: backward vertical integration means moving back towards suppliers.
B wrong: taking over retailers is forward vertical integration.
C wrong: merging with a rival is horizontal integration.
D wrong: unrelated business purchase is conglomerate integration.

33. Answer: A

A correct: forward vertical integration means moving closer to final consumers through distributors/retailers.
B wrong: buying suppliers is backward vertical integration.
C wrong: direct rival merger is horizontal integration.
D wrong: exit is leaving the market.

34. Answer: A

A correct: conglomerate integration means combining firms in unrelated industries.
B wrong: same stage is horizontal.
C wrong: buyer and supplier is vertical.
D wrong: wage reduction is not the definition.

35. Answer: A

A correct: tyres are inputs for cars, so buying a tyre producer is backward vertical integration.
B wrong: forward integration moves towards selling cars to final consumers.
C wrong: tyre producer is not same stage as car manufacturer.
D wrong: tyres are related to car production.

36. Answer: A

A correct: dealerships sell cars to final consumers, so this is forward vertical integration.
B wrong: backward integration would be buying suppliers.
C wrong: dealerships are not at the same production stage as manufacturing.
D wrong: dealerships are related, not unrelated diversification.

37. Answer: A

A correct: two competing banks are at the same stage in the same industry, so horizontal integration.
B wrong: backward integration means buying a supplier.
C wrong: forward integration means buying a distributor/customer-facing stage.
D wrong: banks are not unrelated industries.

38. Answer: A

A correct: food production and hotel operation are unrelated enough to be conglomerate integration.
B wrong: hotel chain is not a supplier of food production.
C wrong: they are not direct rivals at same stage.
D wrong: hotel chain is not simply a distributor of the food producer.

39. Answer: A

A correct: merging with rivals increases market share and may create economies of scale.
B wrong: consumer prices are not guaranteed to fall.
C wrong: monopoly power risk may increase.
D wrong: competition may fall, not become perfect.

40. Answer: A

A correct: horizontal integration can reduce the number of competitors and increase monopoly power.
B wrong: economies of scale may be gained, not necessarily lost.
C wrong: lower average cost is not guaranteed.
D wrong: entry does not automatically occur.

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

41. Answer: A

A correct: buying suppliers gives control over inputs, quality, delivery and input costs.
B wrong: control over raw materials increases, not decreases.
C wrong: demand is not guaranteed to fall.
D wrong: market power may increase.

42. Answer: A

A correct: buying distributors/retailers gives control over routes to market and customer experience.
B wrong: access to customers improves.
C wrong: selling opportunities may increase.
D wrong: branding may strengthen.

43. Answer: A

A correct: conglomerate integration spreads risk because losses in one market may be offset by gains in another.
B wrong: productive efficiency is not guaranteed.
C wrong: managing unrelated businesses can create problems.
D wrong: uncertainty cannot be completely removed.

44. Answer: A

A correct: managers may lack knowledge of the new unrelated industry, causing inefficiency.
B wrong: risk may be spread, not increased infinitely.
C wrong: the firm may become larger.
D wrong: products remain different.

45. Answer: A

A correct: managers may pursue salary, growth, security or prestige instead of shareholder profit.
B wrong: shareholders rarely control every daily decision.
C wrong: consumer information is unrelated.
D wrong: firms normally have managers.

46. Answer: A

A correct: shareholders own the firm, but managers control many day-to-day decisions.
B wrong: consumers do not own the firm by buying products.
C wrong: this is not government ownership.
D wrong: managers do make decisions.

47. Answer: A

A correct: larger firms may increase managers’ salary, status and job security.
B wrong: growth does not only raise dividends.
C wrong: consumer surplus does not necessarily rise.
D wrong: allocative efficiency is not automatic.

48. Answer: A

A correct: empire building/sales growth may serve managers’ interests more than shareholder profit.
B wrong: shareholder profit maximisation is owner interest.
C wrong: P = MC is allocative efficiency.
D wrong: zero output is not managerial self-interest.

49. Answer: A

A correct: linking pay to profit/share price aligns managers’ incentives with owners’ interests.
B wrong: no monitoring worsens agency problems.
C wrong: preventing shareholder voting weakens owner control.
D wrong: hiding accounts increases information asymmetry.

50. Answer: A

A correct: low entry/exit barriers allow hit-and-run entry, forcing incumbents to keep prices lower.
B wrong: high sunk costs make exit difficult and reduce contestability.
C wrong: horizontal merger reduces competitors and raises concentration.
D wrong: principal-agent problem means possible conflict, not guaranteed shareholder-profit maximisation.

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.