Market Structure, Efficiency and Contestability

Question 1

What is meant by a 3-firm ratio?

Answer 1

This measures the total market share of the top 3 firms in the market.

Question 2

What does it mean if a market has a high concentration ratio?

Answer 2

It means that market power is concentrated amongst a few large firms, so the market is therefore less competitive,

Question 3

Give three examples of markets with high concentration ratios

Answer 3

The telecoms, banking and electricity markets e.g. Monopoly, Oligopoly and Duopoly markets have high market concentration.

Question 4

How do you calculate a concentration ratio?

Answer 4

You add the market share of the n firms.

Question 5

What is meant by product differentiation?

Answer 5

When a firm makes its product design, features, or brand perception slightly different from its rivals.

Question 6

In what way is a Pizza Hut pizza differentiated from a Pizza Express pizza?

Answer 6

Pizza Express has a premium product, using thinner dough, fresher ingredients and more authentic Italian flavours whereas Pizza Hut is more widely considered as fast food rather than restaurant food.

Question 7

In what way is a Nokia phone differentiated from an iPhone?

Answer 7

iPhone has a ‘dimple’ which no other phone can use. They also have a slicker design and aim their product at all markets due to it being very fashionable. They are also able to charge a high price due to the popularity of the brand and the premium quality of the product.

Question 8

Define Oligopoly

Answer 8

An Oligopoly is a market structure with a few large firms dominating the market.

Question 9

Give 4 examples of markets which are Oligopolistic.

Answer 9

Banks: Lloyds, Barclays, HSBC, Natwest
Airlines: British Airways, Aer Lingus, Virgin
Supermarkets: Waitrose, Tesco, Sainsbury’s, Morrisons
Mobile Phone providers: Apple, Samsung

Question 10

What would you expect the concentration ratio to be like in an Oligopolistic market?

Answer 10

High

Question 11

What characteristics does an oligopolistic market have?

Answer 11

• Interdependence
• High concentration ratio
• Differentiated product
• Few firms
• High barriers to entry

Question 12

What kinds of behaviour might you observe in an Oligopolistic Market?

Answer 12

Non-price competition and collusion

Question 13

What is meant by non-price competition and give three examples of it?

Answer 13

Competing but avoiding direct price comparisons

• Comparing product quality
• Advertising
• Investing in R&D

Question 14

What is meant by a cartel?

Answer 14

When more than one firm get together and behave/take actions as if they were one firm.

Question 15

Give an example of a Cartel

Answer 15

OPEC

Question 16

What is meant by price leadership?

Answer 16

When one firm is dominant in a market and when it changes price, all other competitors follow them regardless of whether it is a price rise or price fall.

Question 17

Give an example of price leadership

Answer 17

British Gas in the UK energy sector - when they raise price others tend to follow suit.

Question 18

What is meant by collusion?

Answer 18

When firms share information and agree not to compete.

Question 19

Name 2 different ways firms can collude

Answer 19

Price collusion or output collusion e.g. all agree to keep prices high, or agree to carve up the market for a product by agreeing who gets which customers.

Question 20

Give 2 examples of firms found guilty of collusion

Answer 20

Virgin and BA colluded on fuel surcharge on flights but Virgin whistleblew. The big supermarkets colluded on the price of cheese and other dairy products.

Question 21

Why is collusion against the public interest?

Answer 21

Because it means that there is a higher price (with no difference to the quality of the product) for the consumers and they have no control over it.

Question 22

What factors increase the likelihood of collusion in an industry?

Answer 22

• The fewer firms in the industry, the easier it is to come to an agreement
• The more mature the industry, the more likely employees at the firms will know each other and are more likely to collude.

Question 23

What is meant by a price war?

Answer 23

When one company drops price, and others follow suit, causing the first firm to drop in price again and the process continues until a firm gives up, thus returning to the original price. A price war is generally damaging to all firms involved and they usually seek to avoid it.

Question 24

What does interdependence mean?

Answer 24

That the actions of one firm will effect all the other firms in the market.

Question 25

How does this create uncertainty in Oligopolistic markets?

Answer 25

Because it means that firms are unsure about the outcomes of actions they take, as they cannot be sure what their competitors reactions will be. This makes firms seek low risk strategies such as competing using non-price methods.

Question 26

What are the assumptions behind the kinked demand curve?

Answer 26

Assumes interdependence, and that when a firm raises price, others do not follow suit, and that when a firm drops price, others do follow suit.

Question 27

What is game theory?

Answer 27

Game theory is a mathematical model that looks at the payoffs for firms in an Oligopoly market structure based on the decisions they make and how the other firm responds.

Question 28

According, to game theory, how might co-operation and collusion improve the outcome for two firms?

Answer 28

If firms collude then they can formally agree to maintain the bottom left corner so that the best option can be maintained.

Question 29

With reference to game theory, explain why collusion agreements often break down.

Answer 29

However, there is always an incentive in the short run to make profits by undercutting the agreement, particularly if the firm undercutting also acts as a whistle blower to the competition authorities. If the act as a whistle blower, they can often avoid the fine, so they can access the high payoff in the short run without financial penalty. However, this still does not solve the issue that when the collusion breaks down, both firms end up in the top left quadrant and are both worse off.