If markets are contestable, firms are more likely to be allocatively efficient. In the long run, firms operate at the bottom of the average cost curve. This makes them productively efficient. The threat of new entrants affects firms just as much as existing competitors.

How are contestable markets Allocatively efficient?

In theory, perfectly contestable markets result in an efficient allocation of resources as it will result in allocative and productive efficiency. Allocative efficiency occurs when neither too little nor too much of a good is being produced.

Do contestable markets make supernormal profits?

In the long run firms in contestable markets will only make normal profit. Firms can make a supernormal profit in the short run however this attracts new entrants to the market.