Competition policy
55 marks: 12 multiple choice questions, a data response and an essay. Answers are at the end.
WJEC / Eduqas: Question 14 would be a 20-mark question on your papers.
Multiple choice online
The test
1In the UK, the body responsible for investigating mergers, cartels and abuses of a dominant position is the:
- A Office for Budget Responsibility
- B Financial Conduct Authority
- C Competition and Markets Authority
- D Office of Fair Trading, which still exists alongside the CMA
2Which one of the following is most likely to be treated as an abuse of a dominant position?
- A a firm advertising heavily to win customers
- B a dominant firm pricing below cost to drive a new entrant out
- C two small firms merging to compete with a market leader
- D a firm cutting its price because its costs have fallen after investing in new machinery
3A cartel is:
- A an agreement between firms to fix prices, share markets or restrict output
- B a government body that regulates prices
- C a single firm that supplies the whole market and sets price above marginal cost
- D a merger between firms at different stages of production
4The largest fine the CMA can impose on a firm found to have broken competition law is:
- A £1 million
- B 10% of its UK profit
- C the whole of the profit made from the infringement
- D 10% of its worldwide annual turnover
5Before a merger, the three largest supermarkets have market shares of 27%, 15% and 15%. If the second and third largest merge, the two-firm concentration ratio will be:
- A 72%
- B 57%
- C 30%
- D 42%
6Requiring the merging firms to sell some of their shops before a merger is allowed is an example of:
- A a structural remedy
- B a price cap
- C nationalisation
- D a behavioural remedy
7The CMA offers immunity from fines to the first member of a cartel that reports it. The main purpose is to:
- A reduce the cost of running the CMA
- B reward firms for making abnormal profit in markets where entry is difficult
- C increase the number of cartels in the economy
- D make cartels unstable by giving each member an incentive to confess first
8A merger would raise the price of a product by 5% but cut average costs by 15%. On efficiency grounds the authorities might allow it if:
- A the merged firm would have a market share above 50%
- B the firms are in different industries
- C the cost saving outweighs the welfare loss from the higher price and some is passed to consumers
- D the merged firm promises to keep all the savings as profit
9Which one of the following is a limitation of competition policy?
- A it can only be applied to nationalised industries
- B it prevents all mergers from taking place
- C it always leads to higher prices for consumers because firms pass on the cost of fines
- D regulators know less about costs and demand than the firms they investigate
10Resale price maintenance, where a manufacturer forces retailers to charge a set price, is generally illegal because it:
- A lowers the price below the competitive level
- B increases the number of retailers
- C prevents price competition between retailers and keeps prices high
- D makes it harder for the manufacturer to sell its product through independent retailers
11The CMA investigates a merger when the target's UK turnover exceeds a threshold or when the merged firm would supply at least a certain share of a market. That share is:
- A 25%
- B 10%
- C 50%
- D 40%
12Competition policy that makes a market more contestable is most likely to:
- A increase barriers to entry
- B reduce abnormal profit even if the number of firms does not change
- C raise prices towards the monopoly level
- D remove the need for firms to be productively efficient, as entry is no longer a threat
13In 2021 the Competition and Markets Authority fined a group of drug companies more than £260 million (reduced on appeal) for abusing a dominant position in the supply of hydrocortisone tablets to the NHS. The CMA found that the price of a pack of 10mg tablets had risen from 70p in 2008 to £88 by 2016, after the product was de-branded so that it was no longer covered by NHS price controls, and that the dominant supplier had paid would-be rivals to stay out of the market. The NHS was spending over £80 million a year on a drug that had cost it around £500,000 a year. Table 1 shows illustrative figures for the market.
| 2008 | 2016 | 2019 | |
|---|---|---|---|
| Price per pack (£) | 0.70 | 88.00 | 40.00 |
| Packs bought by the NHS (thousand) | 900 | 950 | 1,000 |
| Average cost per pack (£) | 0.50 | 0.60 | 0.60 |
(a)Using Table 1, calculate the supplier's profit on hydrocortisone in 2016. [2]
(b)Using Table 1, explain what the figures suggest about the price elasticity of demand for the drug and why this made the abuse profitable. [4]
(c)With the aid of a diagram, explain how the removal of competition in a market like this harms consumers and the economy. [6]
(d)Explain two reasons why fines alone may not stop firms from abusing a dominant position. [6]
14Assess the view that competition policy is likely to make markets less efficient in the long run. [25]
Answers
Show the answers
AO1 knowledge, AO2 application, AO3 analysis, AO4 evaluation.
| Answer | Why | |
|---|---|---|
| 1 | C | The CMA took over from the Office of Fair Trading and the Competition Commission in 2014. |
| 2 | B | Predatory pricing uses market power to exclude rivals; the others are normal competition. |
| 3 | A | Collusion between supposedly independent firms to behave like a monopoly; it is illegal under the Competition Act 1998. |
| 4 | D | Fines are capped at 10% of worldwide group turnover; the CMA can also disqualify directors and individuals can face criminal charges for cartels. |
| 5 | B | The merged firm would have 30%, the largest 27%: 57%. Sainsbury's and Asda, with shares close to these, were blocked in 2019. |
| 6 | A | Structural remedies change the shape of the market (divestment); behavioural remedies control how the firm acts (price promises, supply obligations). |
| 7 | D | Leniency turns the cartel into a prisoner's dilemma: each firm fears another will confess first, so agreements are harder to sustain. |
| 8 | C | Regulators weigh the deadweight loss from market power against resource savings; passing some saving on protects consumers. |
| 9 | D | Asymmetric information, long investigations and the risk of regulatory capture all limit how well policy works. |
| 10 | C | It removes competition at the retail stage, so consumers pay more than they would if retailers were free to discount. |
| 11 | A | The share of supply test is 25% or more; the turnover test is £70 million or more. |
| 12 | B | A credible threat of entry disciplines incumbents' pricing and costs without entry actually having to occur. |
13 (a) Using Table 1, calculate the supplier's profit on hydrocortisone in 2016. [2: AO2 2]
- AO2 (1) Profit per pack = £88.00 − £0.60 = £87.40
- AO2 (1) Total profit = 950,000 × £87.40 = £83.03 million (accept £83 million)
13 (b) Using Table 1, explain what the figures suggest about the price elasticity of demand for the drug and why this made the abuse profitable. [4: AO2 2, AO3 2]
- AO2 (1) Price rose by over 12,000% between 2008 and 2016 while the quantity bought rose from 900 to 950 thousand packs: demand is almost perfectly price inelastic
- AO3 (1) Hydrocortisone is essential for patients with adrenal insufficiency and has no close substitute, and the NHS must buy it whatever the price, so a price rise loses almost no sales
- AO3 (1) With inelastic demand a monopolist's revenue rises when price rises, so once the price control was removed and rivals were kept out, the profit-maximising price was far above cost
- AO2 (1) Application: profit per pack rose from 20p to £87.40 while average cost barely changed, which is why paying rivals to stay out (reportedly tens of millions) was still worth it
13 (c) With the aid of a diagram, explain how the removal of competition in a market like this harms consumers and the economy. [6: AO1 2, AO2 1, AO3 3]
- AO1 (2) Diagram: AR and MR with MC = AC; the monopoly output Qm where MC = MR and price Pm; the competitive outcome Pc = MC at Qc; the abnormal profit rectangle and the deadweight loss triangle between Qm and Qc
- AO3 (1) With rivals excluded the firm faces the whole market demand and sets price above marginal cost; consumers who still buy pay Pm instead of Pc, a transfer from buyers to the firm
- AO3 (1) Units valued above their cost go unsold (the deadweight loss); resources are misallocated and allocative efficiency is lost; here the buyer is the NHS, so the transfer comes out of other treatments
- AO3 (1) Without competitive pressure the firm has no need to cut costs or improve the product (X-inefficiency and lost dynamic efficiency), and paying rivals to stay out is itself a waste of resources
- AO2 (1) Application: with demand this inelastic the quantity effect is tiny, so most of the harm is the transfer (£80 million a year from the NHS) rather than a large deadweight loss; the fine and the arrival of competitors cut the price to £40 by 2019
Levels: 1 to 2 for a description with a partly correct diagram; 3 to 4 for a correct diagram with the price and welfare loss explained; 5 to 6 for the transfer, the welfare loss and the efficiency effects applied to the case.
13 (d) Explain two reasons why fines alone may not stop firms from abusing a dominant position. [6: AO1 2, AO2 2, AO3 2]
- AO1+AO2+AO3 (3) The fine may be smaller than the gain: here the abuse ran for eight years and earned well over £80 million a year, so even a £260 million fine (capped at 10% of turnover) could be less than the profit made, and a firm weighing expected cost against benefit may still offend, especially if detection is uncertain
- AO1+AO2+AO3 (3) Fines come late and are paid by shareholders, not the managers who decided: investigations take years, the harm to the NHS has already happened, and without director disqualification or criminal sanctions the individuals face little personal risk
- AO1+AO2+AO3 (3) Or: fines do not restore competition, so structural remedies (ending the pay-for-delay deals, encouraging entry) or price regulation are needed to bring the price down; asymmetric information means the regulator may not detect the abuse at all
Maximum 6: two reasons, each explained and applied to the case.
14 Assess the view that competition policy is likely to make markets less efficient in the long run. [25: AO1, AO2 and AO3 16, AO4 9]
Knowledge and analysis (AO1 to AO3)
- Define competition policy (controls on mergers, cartels, abuse of dominance and the promotion of competition, enforced in the UK by the CMA and sector regulators) and the types of efficiency it may affect: allocative, productive, X- and dynamic.
- The case for the view: blocking mergers can stop firms reaching minimum efficient scale, so average costs stay higher (diagram: the trade-off between a cost saving and a welfare loss); preventing dominance reduces the abnormal profit that funds research and development; Schumpeter argued that large firms with market power are the main source of innovation.
- Costs of the policy itself: long investigations delay investment, firms spend on lawyers rather than products, and fear of becoming dominant may deter firms from competing hard; regulators know less than firms about costs and demand, so they make mistakes.
- The case against: cartels and monopolies raise price above marginal cost, restrict output and create deadweight loss; protected firms let costs drift (X-inefficiency); competition policy restores the pressure that forces firms to minimise costs and pass savings on.
- Dynamic efficiency cuts both ways: contestable markets and the threat of entry drive innovation at least as strongly as protected profit; the hydrocortisone case shows dominance used to raise prices, not to innovate; policy can allow efficiency gains, approving mergers with conditions (Vodafone and Three) and exempting cooperation on research.
- Evidence: competition in airlines, telecoms and retail lowered prices and raised productivity; economies with weak competition policy tend to have higher mark-ups and slower productivity growth.
Evaluation (AO4)
- It depends on the type of efficiency: policy almost certainly raises static allocative and productive efficiency; the real argument is about dynamic efficiency, where the evidence that market power is needed for innovation is weak outside a few industries with very high fixed research costs.
- It depends on how the policy is applied: a rigid rule against size would harm efficiency, but UK policy weighs efficiency gains and uses remedies rather than blanket bans; the risk is error and delay, not the principle.
- It depends on the industry: in natural monopolies competition policy gives way to regulation; in digital markets network effects mean dominance can persist without delivering the innovation claimed for it, which is why the 2024 Digital Markets Act gave the CMA new powers.
- Time horizon: short-run costs of investigation and uncertainty are real but small relative to the long-run losses from entrenched monopoly, which compound over decades.
- Counter-risk: regulatory capture and lobbying can turn policy into protection for incumbents, which would support the view, but that is a failure of enforcement rather than of competition policy itself.
Judgement
A supported judgement might conclude that the view is largely wrong: competition policy raises allocative and productive efficiency and, by keeping markets contestable, usually supports rather than harms innovation; it can lower efficiency only where it blocks genuine scale economies or research cooperation, and well-designed policy with efficiency defences and conditional approvals avoids most of that cost.
Marking
Levels, out of 25 (Edexcel splits them as knowledge, application and analysis 16, evaluation 9; AQA marks the whole answer against one set of levels). Top level (21 to 25): a range of points developed in full chains of reasoning, supported by accurate diagrams and real examples, with evaluation that weighs the arguments against each other and reaches a judgement that depends on stated conditions. Middle level (11 to 20): some developed chains, a relevant diagram, evaluation present but one-sided or asserted. Bottom level (1 to 10): points listed or described, little use of theory or examples, judgement missing or unsupported. WJEC: a 20-mark question with AO1 6, AO3 6 and AO4 8.