Chapter 5
Teacher notes
Concentrated markets: theory of
oligopoly
Activity, page 52.
1 Five firm concentration ratio is 5:80 and the 3 firm ratio is 3:64.
2 Tesco’s market share is above 25 per cent, so could be seen as being a monopoly (in the legal rather
than economic sense).
3 16 per cent.
4 The larger, dominant firms will be able to negotiate bulk-buying deals with suppliers, whereas
smaller firms may not, and so smaller firms may have to set higher prices and therefore possibly
lose customers. Smaller firms will also not be able to use cross-subsidisation to fund price wars,
which again may mean that they lose customers.
Activity, page 60.
5 Companies in oligopoly often produce a number of different brands, because this allows the
company to gain greater market share (that is, their products will appeal to a greater number of
customers with different tastes/preferences). It is a form of non-price competition.
6
If General Electric Company (GEC) tries to raise its price, then consumers will switch to other brands
that have remained at the same price, and so GEC will likely lose market share. If GEC lowers its
price, then its competitors will react by also lowering their price, that is, a price war, and so will not
gain much market share, if any.
7 Collusion refers to the forming of some sort of agreement between firms, usually to fix prices or
output.
Reasons why collusion would be difficult in this industry:
a) at least 10 companies, some of which have more than one brand, making it difficult for
companies to agree
b) goods not homogenous (lots of differentiation, as indicated by a number of brands offered by
some companies)
c) difficult to prevent other companies from selling white goods
d) barriers to entry fairly low (as indicated by rapid entry of East Asian companies into this
market).
Reasons why collusion might work in this industry:
e) possible to create artificial barriers to entry, such as UK safety requirements (as a result of
lobbying by companies to government for example)
f) some dominant firms (Electrolux, GEC, Hoover, Whirlpool) who could collude without input
from the other companies listed.
AQA Economics A2 © Nelson Thornes Ltd 2009
1
Chapter 5
Teacher notes
Activity, page 62.
8 ‘Barriers to entry’ refers to anything that may prevent a new firm from joining an industry; they can
be natural or artificial.
9 If barriers to entry exist, then market supply will be restricted. This raises the market price, reducing
consumer surplus.
10 Resources are allocated most efficiently when firms can enter and leave an industry freely, because
firms will enter an industry where supernormal profits exist and leave where losses are being made,
that is, as in perfect competition where the long-run outcome is productively and allocatively
efficient. If barriers to entry exist, then firms cannot enter an industry to appropriate any
supernormal profits that are being made.
AQA Examination-style questions, page 64.
Data response question 1:
a) A duopoly is a specific type of oligopoly, where the market is dominated by just two companies:
extract C refers to Moody’s and Standard and Poor’s as having a duopoly. ‘Concentration in too
few hands’ refers to the percentage of the market controlled by a small number of firms, in this case
the small number of credit ratings agencies.
b) ‘Risk averse’ means an unwillingness to take a risk, or change established behaviour. In this
example, the credit ratings agencies were risk averse in the sense that they did not want to provide
ratings that were negative given that they were funded by the companies whom they were rating. A
diagram that could be used would be the kinked demand curve; this shows that firms are unwilling
to change strategy from their fixed ‘kink’, that is, they are risk averse.
c) Collusion occurs when:
i) there are a small number of firms (true in this case)
ii) products/services are homogenous (true in this case)
iii) there are high barriers to entry (true in this case).
Firms in the credit ratings industry could collude in a number of ways, including agreeing to keep
ratings positive in order to continue gaining funding, or fixing prices of providing ratings, or
agreeing to carry out a credit rating in a standard way. Consumers are more likely to suffer if the
type of collusion is one of the first two, rather than the latter.
Essay question 2:
d) Define oligopoly.
Define interdependence.
Could draw kinked demand curve to illustrate interdependence, that is, effect on market share if price
rises or falls.
Could use a game theory matrix to illustrate the impact on profits for one company of another company
changing its strategy.
e) Factors could include:
i) size of market
ii) degree of concentration (high concentration could mean collusion and higher prices, or
alternatively highly aggressive price cutting)
iii) degree of homogeneity of products (the more homogenous the products, the greater the chance
of price competition rather than non price competition)
iv) number of brands owned by a company (each brand likely to cater to consumers with a different
price elasticity of demand [PED] so therefore likely to be offered at different prices)
v) any investigatory action currently underway or suspected relating to collusive behaviour
vi) the level of barriers to entry (the higher the barriers to entry, the higher the market price is likely
to be).
AQA Economics A2 © Nelson Thornes Ltd 2009
2