Oligopoly

50 marks: 12 multiple choice questions, a data response and an essay. Answers are at the end.

AQA: Question 14 would be a 25-mark question on your papers.

Edexcel: Questions 3, 4 and 13 (d) use the kinked demand curve model, which is not on your specification. You can still attempt them, and referring to the model in an essay still earns credit. Question 14 would be a 25-mark question on your papers.

OCR: Question 14 would be a 25-mark question on your papers.

1In a market, the five largest firms have market shares of 24%, 19%, 17%, 11% and 9%. The four-firm concentration ratio is:

A 60%
B 71%
C 80%
D 29%

2A firm in an oligopoly is said to be interdependent because:

A its demand depends on the level of consumers' incomes
B its profits depend on the strength of the barriers to entry that protect the market
C its costs depend on the prices charged by its suppliers
D its decisions on price and output depend on how it expects rivals to react

3In the kinked demand curve model, a firm that raises its price above the kink expects that:

A rivals will not follow, so demand is relatively elastic above the kink
B rivals will match the rise, so demand is relatively inelastic above the kink
C demand will be perfectly inelastic above the kink
D rivals will cut their prices and start a price war

4A weakness of the kinked demand curve model is that it:

A predicts that prices in oligopoly will change frequently
B assumes that rival firms are price takers who cannot influence the market price
C does not explain how the price at the kink was set in the first place
D applies only to markets in which there is a single firm

5Tacit collusion differs from overt collusion in that tacit collusion:

A requires a written contract between the firms setting out prices and quotas
B can only take place between two firms, whereas overt collusion needs a cartel of several
C is organised through a formal cartel that sets quotas for each member
D involves no formal agreement between the firms

6A member of a cartel has an incentive to cheat on its output quota because:

A its average cost rises when it produces more, so it needs a larger quota to cover its costs
B at the cartel price, each extra unit it sells adds more to its revenue than to its cost
C the cartel price is below the competitive price, so each member's profit margin is thin
D selling more than its quota raises the market price and so raises every member's profit

7Which of the following conditions makes collusion between firms more likely to succeed?

A low barriers to entry into the market
B large differences in costs between the firms
C a small number of firms selling a similar product
D rapid changes in the technology used in the industry

Use the information below for questions 8 to 9.

Two airlines, Northline and Skywest, are the only carriers on a route. Each must choose standard or discount fares for the season without knowing the other's choice. The table shows the profit each would earn, in £m, with Northline's profit first in each cell.

	Skywest: standard	Skywest: discount
Northline: standard	12, 12	4, 16
Northline: discount	16, 4	7, 7

8The dominant strategy for each airline is to choose:

A discount fares, whatever the other airline does
B standard fares, whatever the other airline does
C neither airline has a dominant strategy
D discount fares only if the other airline chooses standard fares

9The outcome in which both airlines choose discount fares is:

A a Nash equilibrium, but not the outcome that maximises their joint profit
B a Nash equilibrium that also maximises their joint profit, since neither can do better
C the outcome the two airlines would choose if they could collude and enforce the agreement
D not a Nash equilibrium, because each airline could gain by switching to standard fares

10Predatory pricing differs from limit pricing in that predatory pricing:

A is only used by firms in perfectly competitive markets, where price already equals MC
B is permitted under UK competition law, whereas limit pricing is treated as an abuse
C sets price below average variable cost to drive an existing rival out of the market
D sets a price just low enough to make entry unprofitable, without making a loss itself

11Which of the following is the best example of non-price competition between oligopolists?

A a group of firms agreeing output quotas in order to keep the market price above cost
B a petrol retailer matching a rival's price cut within hours of it being announced
C a firm pricing below cost for several months in order to remove a rival from the market
D a mobile network including a streaming subscription with its contracts

12A market is more likely to be a natural oligopoly when:

A the firms in the market are price takers who cannot influence the price by changing output
B the minimum efficient scale is large relative to the size of the market
C the government has removed all barriers to entry, so any firm may enter the market freely
D the products sold by the firms are close to homogeneous, so buyers switch readily between them

13In December 2024 the UK Competition and Markets Authority cleared the merger of Vodafone and Three, reducing the number of mobile network operators in the UK from four to three. The CMA accepted commitments from the merged firm, including a programme of network investment and caps on some tariffs for three years. Table 1 shows market shares before and after the merger. Figures are illustrative.

Table 1: UK mobile network market shares (%)
Network	Before the merger	After the merger
EE	31	31
O2	27	27
Vodafone	23	42
Three	19

(a)Using Table 1, calculate the three-firm concentration ratio before the merger. [2]

(b)Explain why the merger is likely to increase interdependence between the remaining networks. [4]

(c)Using a numerical example in a payoff matrix, explain why the three networks might be tempted to collude on prices, and why such an agreement would be difficult to maintain. [6]

(d)With the aid of a diagram, explain why mobile contract prices might remain unchanged even if the networks' costs rise. [6]

14Discuss the view that oligopoly is the most desirable market structure. [20]

Answers

Show the answers

	Answer	Why
1	B	The four-firm ratio adds the four largest shares: 24 + 19 + 17 + 11 = 71%.
2	D	Interdependence means each firm must consider the likely reaction of its rivals before changing price or output.
3	A	Rivals are assumed to leave their prices alone when one firm raises its price, so the firm loses many customers and demand above the kink is elastic.
4	C	The model takes the current price as given and explains why it is sticky; it says nothing about how that price was reached.
5	D	Tacit collusion is an understanding reached without any explicit agreement, often by following a price leader.
6	B	The cartel price is held above marginal cost, so any one member gains by quietly selling more at that price.
7	C	Few firms and similar products make an agreement easier to reach and cheating easier to spot; the other conditions make agreement harder to hold together.
8	A	Discount beats standard for each airline whichever the rival picks: 16 > 12 if the rival stays standard, and 7 > 4 if the rival discounts.
9	A	Neither airline can gain by changing its choice alone, so it is a Nash equilibrium; but joint profit is 14, against 24 if both charged standard fares.
10	C	Predatory pricing aims to remove a rival that is already in the market; limit pricing aims to deter a firm that has not yet entered.
11	D	Non-price competition means winning customers through product features, service or branding rather than through price.
12	B	If a firm must be large to reach lowest average cost, the market only has room for a few efficient firms.

13 (a) Using Table 1, calculate the three-firm concentration ratio before the merger. [2]

31 + 27 + 23 (1 mark)
81% (1 mark; the % sign or 'of the market' is needed for the second mark)

13 (b) Explain why the merger is likely to increase interdependence between the remaining networks. [4]

Interdependence: each firm's sales depend on rivals' decisions as well as its own, so it must consider their likely reaction (1 mark)
With three networks rather than four, each holds a larger share, so a price or output change by one has a bigger effect on the others' sales (1 mark)
Rivals are therefore more likely to notice and respond, for example by matching a price cut (1 mark)
Application: the merged network holds 42% of the market, so if it cut contract prices EE and O2 would lose more customers than before and would almost certainly respond (1 mark)

13 (c) Using a numerical example in a payoff matrix, explain why the three networks might be tempted to collude on prices, and why such an agreement would be difficult to maintain. [6]

A 2 × 2 payoff matrix for two firms choosing a high or a low price, with consistent numbers: both high gives the highest joint profit, each firm earns most by going low when the other stays high, and both low leaves both worse off than both high (2 marks)
Temptation: by agreeing to keep prices high the firms share the collusive (joint-profit-maximising) outcome rather than the lower profits of the both-low Nash equilibrium (2 marks)
Instability: low price is each firm's dominant strategy, so each gains by secretly undercutting; the agreement cannot be enforced in law because collusion is illegal, and with three networks a cheat is tempted by the large gain from first-mover undercutting (2 marks)
Marking: credit the matrix only if the numbers support the argument (joint high > both low; defector's payoff > collusive payoff). A matrix with three firms is not required; two firms is enough.

13 (d) With the aid of a diagram, explain why mobile contract prices might remain unchanged even if the networks' costs rise. [6]

Diagram: a demand (AR) curve kinked at the current price P, elastic above the kink and inelastic below; a marginal revenue curve with a vertical gap directly below the kink; MC1 and a higher MC2 both passing through the gap; output Q at the kink (2 marks)
Explanation of the kink: rivals are assumed to match a price cut but not a price rise, so a rise loses many customers (elastic) while a cut wins few (inelastic) (1 mark)
The kink makes MR discontinuous at output Q (1 mark)
A rise in costs from MC1 to MC2 that stays within the gap leaves MC = MR at the same output, so the profit-maximising price stays at P (1 mark)
Application: a network that raised contract prices alone would expect to lose customers to the other two, so it absorbs the cost rise instead (1 mark)
Levels: 1 to 2 marks for a basic description with a partly correct diagram; 3 to 4 for a correct diagram with the kink explained; 5 to 6 for a fully labelled diagram with the MR gap used to show that MC = MR output, and so price, is unchanged, applied to the networks.

14 Discuss the view that oligopoly is the most desirable market structure. [20]

Analysis

Define oligopoly: a few large firms with a high concentration ratio, high barriers to entry, interdependence and price-making power; products may be homogeneous or differentiated.
Against the view (the traditional case): interdependence can lead to collusion, overt or tacit; a collusive oligopoly behaves like a monopoly, restricting output to where MC = MR and charging a price above marginal cost. Show on a diagram: price above MC (allocative inefficiency), output below the minimum of AC (productive inefficiency), abnormal profit and a deadweight welfare loss.
Against: barriers to entry allow abnormal profit to persist, and the absence of competitive pressure can lead to X-inefficiency. Price-fixing cases (for example the European Commission's fines on truck makers and the CMA's cases against construction and pharmaceutical firms) show the harm to consumers.
For the view: oligopolists earn the profits that fund research and development, so oligopoly may deliver dynamic efficiency that perfect competition cannot; pharmaceuticals, cars and consumer electronics are oligopolies that innovate heavily.
For: large firms reach economies of scale, so average cost and possibly price are lower than many small firms could achieve; in a natural oligopoly a few large firms is the efficient outcome.
For: non-price competition brings consumers choice, quality and service, and price competition between oligopolists can be fierce (UK supermarkets and the entry of discounters); the kinked demand curve suggests prices are stable, which helps consumers and firms to plan.
Compare with the alternatives: perfect competition is allocatively and productively efficient but has no scope for R&D or scale economies; monopoly has scale and funds for R&D but no competitive pressure at all; oligopoly sits between the two.

Evaluation

It depends on how the oligopolists behave: a competitive oligopoly can come close to the competitive outcome, a collusive one close to monopoly. The market structure alone does not fix the result.
It depends on contestability: where barriers to entry are low, the threat of entry keeps prices and profits down even with few firms.
It depends on the industry: in industries with large economies of scale or high R&D costs, oligopoly may be the only structure that can deliver low costs and innovation; in industries with low minimum efficient scale, more competition would serve consumers better.
It depends on regulation: with an effective competition authority (fines for cartels, merger control, price caps as in the Vodafone and Three case), many of the costs of oligopoly can be contained while the benefits remain.
'Desirable' for whom: producers earning abnormal profit, consumers paying higher prices, or workers in large firms with secure jobs may judge it differently.

Judgement

A supported judgement might conclude that no single structure is most desirable in general: oligopoly is likely to be the best available structure in industries where scale and innovation matter, provided the firms compete rather than collude and regulation is credible, but it is inferior to more competitive structures where entry is easy and scale economies are small.

Marking

Top band (16 to 20): a range of points developed in full chains of reasoning, supported by an accurate diagram and real examples, with evaluation that weighs the arguments and reaches a judgement that depends on stated conditions. Middle band (9 to 15): some developed chains, a relevant diagram, evaluation that is present but one-sided or asserted. Bottom band (1 to 8): points listed or described, little use of theory or examples, judgement missing or unsupported.