The Theory of Contestable Markets (Baumol, Panzar, Willig, 1982)

The Theory of Contestable Markets, developed by Baumol, Panzar, and Willig in 1982, suggests that even in markets with few firms, competition can be intense if there are low barriers to entry and exit. This means that potential new competitors can enter if prices are high and exit easily if they aren’t profitable, which pressures existing firms to keep prices low and operate efficiently. Essentially, the threat of new entrants helps maintain competitive prices and behavior, making a market behave as if many firms are competing, even if only a few are actually present.