Abstract
This essay discusses the development of the notion of contestable markets—the idea that optimal Pareto conditions can be induced by facilitating ultrafree entry into and exit from markets—set within the development of applied economics. The role of potential competition in influencing the behavior of incumbent suppliers had been discussed previously, but the work of William Baumol, Elizabeth Bailey, and others, they claimed, offered a more rigorous and internally consistent framework of analysis and a sounder basis for economic policymaking. This article outlines the history of the development of the theory and provides insights into the roles of key figures and institutions. It does this in the context of the role contestability played in influencing the deregulation of US airlines in the 1970s and in terms of the empirical findings of subsequent studies of the implications of this liberalization. Overall, it is also set against an intellectual background when applied and empirical research was becoming a more central part of political economy.
The text of this article is only available as a PDF.
References
Albon, R.
1995
. “William Baumol's Contributions to Public Utility Economics
.” Agenda: A Journal of Policy Analysis and Reform
2
:489
–93
.Alexander, C., and Y.-H. A. Lee.
2004
. “The Economics of Regulatory Reform: Termination of Airline Computer Reservation System Rules
.” Yale Journal on Regulation
21
, no. 2
: 369
–439
.Backhouse, R. E., and J. Biddle.
2000
. “The Concept of Applied Economics: A History of Ambiguity and Multiple Meanings
.” In Toward a History of Applied Economics
, edited by Roger E. Backhouse and Jeff Biddle. History of Political Economy 32
(supplement
): 1
–24
.Backhouse, R. E., and B. Cherrier.
2017a
. “The Age of the Applied Economist: The Transformation of Economics since the 1970s
.” In The Age of the Applied Economist: The Transformation of Economics since the 1970s
, edited by Roger E. Backhouse and Béatrice Cherrier. History of Political Economy 49
(supplement
): 1
–33
.Backhouse, R. E., and B. Cherrier, eds.
2017b
. The Age of the Applied Economist: The Transformation of Economics since the 1970s
. Supplemental issue to vol. 49
of History of Political Economy. Durham, N.C.
: Duke University Press
.Bailey, E. E., ed.
1976
. Selected Economic Writings of William J. Baumol
. New York
: New York University Press
.Bailey, E. E.
1981
. “Contestability and the Design of Regulatory and Antitrust Policy
.” American Economic Review
71
:178
–83
.Bailey, E. E.
1982
. Forward to Contestable Markets and the Theory of Industry Structure
, by W. J. Baumol, J. C. Panzar, and R. D. Willig. New York
: Harcourt Brace Jovanovich
.Bailey, E. E.
1985
. “Airline Deregulation in the United States: The Benefits Provided and the Lessons Learned
.” International Journal of Transport Economics
12
:119
–44
.Bailey, E. E.
1986
. “Price and Productivity Change Following Deregulation: The US Experience
.” Economic Journal
96
:1
–17
.Bailey, E. E.
2002
. “Aviation Policy: Past and Present
.” Southern Economic Journal
69
:12
–20
.Bailey, E. E., and W. J. Baumol.
1984
. “Deregulation and the Theory of Contestable Markets
.” Yale Journal on Regulation
1
:111
–37
.Bailey, E. E., D. R. Graham, and D. P. Kaplan.
1985
. Deregulating the Airlines
. Cambridge, Mass.
: MIT Press
.Bailey, E. E., and J. C. Panzar.
1981
. “The Contestability of Airline Markets during the Transition to Deregulation
.” Law and Contemporary Problems
44
:125
–45
.Bailey, E. E., and R. D. Willig.
1992
. “William J. Baumol
.” In New Horizons in Economic Thought: Appraisals of Leading Economists
, edited by W. J. Samuels, 30
–57
. Aldershot
: Edward Elgar
.Bain, J. S.
1950
. “Workable Competition in Oligopoly: Theoretical Considerations and Some Empirical Evidence
.” American Economic Review
40
:35
–47
.Bain, J. S.
1956
. Barriers to New Competition
. Cambridge, Mass.
: Harvard University Press
.Baumol, W. J.
1977
. “On the Proper Cost Tests for Natural Monopoly in a Multiproduct Industry
.” American Economic Review
67
:809
–22
.Baumol, W. J.
1981
. Testimony of William J. Baumol: United States v. AT&T, Civil Action no. 74-1698
. William J. Baumol Papers, box 68, folder “Legal Testimony—United States v. AT&T (1981).” David M. Rubenstein Rare Book & Manuscript Library, Duke University
.Baumol, W. J.
1982
. “Contestable Markets: An Uprising in the Theory of Industry Structure
.” American Economic Review
72
:1
–15
.Baumol, W. J.
1984
. “On My Attitudes: Sociopolitical and Methodological
.” American Economist
28
:5
–9
.Baumol, W. J.
1989
. “On the Career of a Microeconomist
.” In vol. 2
of Recollections of Eminent Economists
, edited by J. A. Kregel. London
: Macmillan
.Baumol, W. J., E. E. Bailey, and R. D. Willig.
1977
. “Weak Invisible Hand Theorems on the Sustainability of Multiproduct Natural Monopoly
.” American Economic Review
67
:350
–65
.Baumol, W. J., and Y. M. Braunstein.
1977
. “Empirical Studies of Scale Economies and Production Complementarity: The Case of Journal Publication
.” Journal of Political Economy
85
:1037
–48
.Baumol, W. J., and D. Fischer.
1978
“Cost-Minimizing Number of Firms and Determination of Industry Structure
.” Quarterly Journal of Economics
92
:439
–67
.Baumol, W. J., J. C. Panzar, and R. D. Willig.
1982
. Contestable Markets and the Theory of Industry Structure
. New York
: Harcourt Brace Jovanovich
.Baumol, W. J., J. C. Panzar, and R. D. Willig.
1983
. “Contestable Markets: An Uprising in the Theory of Industry Structure; Reply
.” American Economic Review
73
:491
–96
.Baumol, W. J., and R. D. Willig.
1981
. “Fixed Costs, Sunk Costs, Entry Barriers, and Sustainability of Monopoly
.” Quarterly Journal of Economics
96
:405
–31
.Baumol, W. J., and R. D. Willig.
1986
. “Contestability: Developments since the Book
.” Oxford Economic Papers
38
:9
–36
.Beker, V. A.
2022
. “Baumol's Contribution to Telecommunications Regulation
.” In “A Symposium on the Work of William J. Baumol: Heterodox Inspirations and Neoclassical Models,” edited by L. Fiorito, S. Scheall, and C. E. Suprinyak, special issue, Research in the History of Economic Thought and Methodology
40B
:67
–79
.Bishop, S., and M. Walker.
2010
. The Economics of EC Competition Law: Concepts, Application, and Measurement
. London
: Sweet and Maxwell
.Borenstein, S.
1991
. “The Dominant-Firm Advantage in Multiproduct Industries: Evidence from the US Airlines
.” Quarterly Journal of Economics
106
:1237
–66
.Breyer, S.
1982
. Regulation and Its Reform
. Cambridge, Mass.
: Harvard University Press
.Breyer, S.
1999
. “Airline Deregulation Act of 1978
.” Speech to the Air and Space Law Forum of the American Bar Association
, Arlington, Va
. https://www.c-span.org/video/?119010–1/airline-deregulation-act-1978.Brock, W. A.
1983
. ”Contestable Markets and the Theory of Industry Structure: A Review Article
.” Journal of Political Economy
91
:1055
–66
.Button, K. J.
2015
. “A Book, the Application, and the Outcomes: How Right Was Alfred Kahn in The Economics of Regulation about the Effects of the Deregulation of the US Domestic Airline Market?
” History of Political Economy
47
:1
–39
.Button, K. J., and K. Johnson.
1998
. “Incremental versus Trend-Break Change in Airline Regulation
.” Transportation Journal
37
:25
–34
.Button, K. J., and D. Swann, eds.
1989
. The Age of Regulatory Reform
. Oxford
: Oxford University Press
.Cairns, R. D., and J. W. Galbraith.
1990
. “Artificial Compatibility, Barriers to Entry, and Frequent-Flyer Programs
.” Canadian Journal of Economics
23
:807
–16
.Call, G. D., and T. E. Keeler.
1985
. “Airline Deregulation, Fares, and Market Behavior: Some Empirical Evidence
.” In Analytic Studies in Transport Economics
, edited by A. F. Daugherty, 221
–47
. Cambridge
: Cambridge University Press
.Card, D., and A. B. Krueger.
1994
. “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania
.” American Economic Review
84
:772
–93
.Carron, A. S.
1981
. Transition to a Free Market: Deregulation of the Air Cargo Industry
. Washington, D.C.
: Brookings Institution
.Caves, D. W., L. R. Christensen, and M. W. Tretheway.
1984
. “Economies of Density versus Economies of Scale: Why Trunk and Local Service Airline Costs Differ
.” RAND Journal of Economics
15
:471
–89
.Caves, R. E.
1962
. Air Transport and Its Regulators: An Industry Study
. Cambridge, Mass.
: Harvard University Press
.Clark, J. M.
1940
. “Toward a Concept of Workable Competition
.” American Economic Review
30
:241
–56
.Coase, R. H.
2006
. “The Conduct of Economics: The Example of Fisher Body and General Motors
.” Journal of Economics and Management Strategy
15
:255
–78
.Colton, C.
2022
. “William Baumol and Contestability: From AT&T to Platforms
.” In “A Symposium on the Work of William J. Baumol: Heterodox Inspirations and Neoclassical Models,” edited by L. Fiorito, S. Scheall, and C. E. Suprinyak, special issue, Research in the History of Economic Thought and Methodology
40B
:81
–105
.Deaton, A.
2007
. “Letter from America: Random Walks by Young Economists
.” RES Newsletter
, April
. https://www.princeton.edu/∼deaton/downloads/letterfromamerica_apr2007_random_walk.html.Dekker, E.
2022
. “Introduction—the Work of William J. Baumol: Heterodox Inspirations and Neoclassical Models
.” In “A Symposium on the Work of William J. Baumol: Heterodox Inspirations and Neoclassical Models,” edited by L. Fiorito, S. Scheall, and C. E. Suprinyak, special issue, Research in the History of Economic Thought and Methodology
40B
:3
–10
.Douglas, G. W., and J. C. Miller.
1974
. Economic Regulation of Domestic Air Transport: Theory and Policy
. Washington, D.C.
: Brookings Institution
.Dresner, M., J.-S. C. Lin, and R. Windle.
1996
. “The Impact of Low-Cost Carriers on Airport and Route Competition
.” Journal of Transport Economics and Policy
30
:309
–28
.Eisner, M. C.
1991
. Antitrust and the Triumph of Economics: Institutions, Expertise, and Policy Change
. Chapel Hill
: University of North Carolina Press
.Faulhaber, G. R.
1975
. “Cross-Subsidization: Pricing in Public Enterprise
.” American Economic Review
65
:966
–77
.Fukui, H.
2010
. “An Empirical Analysis of Airport Slot Trading in the United States
.” Transportation Research
B 44
:330
–57
.Gilad, S. B., S. Kaish, and P. D. Loeb.
1984
. “From Economic Behavior to Behavioral Economics: The Behavioral Uprising in Economics
.” Journal of Behavioral Economics
13
:1
–22
.Gilbert, R. J.
1989
. “The Role of Potential Competition in Industrial Organization
.” Journal of Economic Perspectives
3
:107
–27
.Good, D. H., L.-H. Röller, and R. C. Sickles.
1993
. “US Airline Deregulation: Implications for European Transport
.” Economic Journal
103
:1028
–41
.Graham, D. R., D. P. Kaplan, and D. S. Sibley.
1983
. “Efficiency and Competition in the Airline Industry
.” Bell Journal of Economics
14
:118
–38
.Grether, D. M., R. M. Isaac, and C. R. Plott.
1981
. “The Allocation of Landing Rights by Unanimity among Competitors
.” American Economic Review
71
:166
–71
.Kahn, A. E.
1979
. “Applications of Economics to an Imperfect World
.” American Economic Review
69
:1
–13
.Kahn, A. E.
1988a
. The Economics of Regulation: Principles and Institutions
. Cambridge, Mass.
: MIT Press
.Kahn, A. E.
1988b
. “Surprises of Airline Deregulation
.” American Economic Review
78
:316
–22
.Kahn, A. E.
2004
. Lessons from Deregulation: Telecommunications and Airlines after the Crunch
. Washington, D.C.
: Brookings Institution Press
.Keeler, T. E.
1972
. “Airline Regulation and Market Performance
.” Bell Journal of Economics and Management Science
3
:399
–424
.Keeler, T. E.
1984
. “Theories of Regulation and the Deregulation Movement
.” Public Choice
44
:103
–45
.Keyes, L. S.
1949
. “National Policy toward Commercial Aviation—Some Basic Problems
.” Journal of Air Law and Commerce
16
:280
–97
.Keyes, L. S.
1951
. “Passenger Fare Policies of the Civil Aeronautics Board
.” Journal of Air Law and Commerce
18
:46
–77
.Krueger, A. B.
2001
. “An Interview with William J. Baumol
.” Journal of Economic Perspectives
15
:211
–31
.Landau, E.
2017
. “Economist Elizabeth E. Bailey *72 Looks Back on a Pioneering Career
.” Princeton Alumni Weekly
, October
4
. https://paw.princeton.edu/article/economist-elizabeth-e-bailey-72-looks-back-pioneering-career.Levine, M. E.
1965
. “Is Regulation Necessary? California Air Transportation and National Regulatory Policy
.” Yale Law Journal
74
:1416
–47
.Levine, M. E.
1987
. “Airline Competition in Deregulated Markets: Theory, Firm Strategy, and Public Policy
.” Yale Journal on Regulation
4
:393
–494
.Levine, M. E.
1991
. “Airline Deregulation: A Perspective
.” Antitrust Law Journal
60
:687
–94
.Lin, M. H.
2008
. “Airline Alliances and Entry Deterrence
.” Transportation Research
E 4
:637
–52
.Littlechild, S.
2008
. “Chairs of Applied Economics and Economic Theory
.” Presented at a conference in honor of the sixty-fifth birthday of Professor David M. G. Newbery. https://www.jbs.cam.ac.uk/wp-content/uploads/2024/01/eprg-caeet14sept08.pdf.Meyer, J. R., and W. B. Tye.
1988
. “Toward Achieving Workable Competition in Industries Undergoing a Transition to Deregulation: A Contractual Equilibrium Approach
.” Yale Journal on Regulation
5
:272
–97
.Moore, T. G.
1986
. “US Airline Deregulation: Its Effects on Passengers, Capital, and Labor
.” Journal of Law and Economics
29
:1
–28
.Morrison, S. A.
2001
. “Actual, Adjacent, and Potential Competition: Estimating the Full Effects of Southwest Airlines
.” Journal of Transport Economics and Policy
35
:239
–56
.Morrison, S. A., and C. Winston.
1986
. The Economic Effects of Airline Deregulation
. Washington, D.C.
: Brookings Institution
.Morrison, S. A., and C. Winston.
1987
. “Empirical Implications and Tests of the Contestability Hypothesis
.” Journal of Law and Economics
30
:53
–66
.Morrison, S. A., and C. Winston.
1989
. “Enhancing the Performance of the Deregulated Air Transportation System
.” Brookings Papers on Economic Activity: Microeconomics
20
:61
–123
.Niskanen, W. A.
1988
. Reaganomics: An Insider's Account of the Policies and the People
. Oxford
: Oxford University Press
.Panzar, J. C., and R. D. Willig.
1977
. “Economies of Scale in Multi-Output Production
.” Quarterly Journal of Economics
91
:481
–93
.Panzar, J. C., and R. D. Willig.
1981
. “Economies of Scope
.” American Economic Review
71
:268
–72
.Peltzman, S.
1976
. “Toward a More General Theory of Regulation
.” Journal of Law and Economics
19
:211
–40
.Perrakis, S.
1982
. Review of Contestable Markets and the Theory of Industry Structure, by William J. Baumol, John C. Panzar, and Robert D. Willig
. Canadian Journal of Economics
15
:774
–80
.Pulsifer, R.
1975
. Regulatory Reform: Report of the CAB Special Staff
. Washington, D.C.
: Civil Aeronautics Board
.Rassenti, S., V. Smith, and R. L. Bulfin.
1982
. “A Combinatorial Auction Mechanism for Airport Time Slot Allocation
.” Bell Journal of Economics
13
:402
–17
.Samuelson, P. A.
1947
. Foundations of Economic Analysis
. Cambridge, Mass.
: Harvard University Press
.Schiller, R.
2019
. “The Curious Origins of Airline Deregulation: Economic Deregulation and the American Left
.” Business History Review
93
:729
–53
.Schwartz, M.
1986
. “The Nature and Scope of Contestability Theory
.” Oxford Economic Papers
38
:37
–57
.Schwartz, M., and R. J. Reynolds.
1983
. “Contestable Markets: An Uprising in the Theory of Industry Structure; Comment
.” American Economic Review
73
:488
–90
.Shackle, G. L. S.
1967
. The Years of High Theory: Invention and Tradition in Economic Thought, 1926–1939
. Cambridge
: Cambridge University Press
.Shepherd, W. G.
1995
. “Contestability and Competition: Once More
.” Land Economics
71
:299
–309
.Snow, J. W.
1975
. “Aviation Regulation: A Time for Change
.” Journal of Air Law and Commerce
41
:637
–64
.Sosnick, S. H.
1958
. “A Critique of Concepts of Workable Competition
.” Quarterly Journal of Economics
72
:380
–423
.Spence, A. M.
1983
. “Contestable Markets and the Theory of Industry Structure: A Review Article
.” Journal of Economic Literature
21
:981
–90
.Stigler, G. J.
1971
. “The Theory of Economic Regulation
.” Bell Journal of Economics and Management Science
2
:3
–21
.Strassmann, D.
1983
. “Contestable Markets and Dynamic Limit Pricing in the Deregulated Airline Industry
.” PhD diss., Harvard University
.Svorenčík, A.
2017
. “Allocating Airport Slots: The History of Early Applied Experimental Research
.” In The Age of the Applied Economist: The Transformation of Economics since the 1970s
, edited by Roger E. Backhouse and Béatrice Cherrier. History of Political Economy 49
(supplement
): 240
–63
.Thaler, R. H.
2016
. “Behavioral Economics: Past, Present, and Future
.” American Economic Review
106
:1577
–600
.US General Accounting Office
. 2001
. Aviation Competition: Challenges in Enhancing Competition in Dominated Markets
. GAO/01-518T. Washington, D.C.
: US General Accounting Office
.Weitzman, M. L.
1983
. “Contestable Markets: An Uprising in the Theory of Industry Structure; Comment
.” American Economic Review
73
:486
–87
.Copyright 2025 by Duke University Press
2025
Issue Section:
Articles
