Market structures and contestability: Practice Questions

In an oligopoly, firms often experience interdependence. Which of the following best explains why firms might engage in collusion?

In an oligopoly, two firms are deciding whether to 'Collude' or 'Compete'. The payoff matrix (Profit in \$ millions) is as follows:

Firm B Collude: (A: 50, B: 50)
Firm B Compete: (A: 10, B: 70) [if A colludes]
Firm A Compete, Firm B Collude: (A: 70, B: 10)
Both Compete: (A: 20, B: 20)

Based on game theory, which of the following best describes the likely outcome in a one-shot game without a binding agreement?

Which of the following conditions is a necessary requirement for third-degree price discrimination to be successful in a monopoly market structure?

In the context of market structures, which condition is most likely to result in a natural monopoly?

Consider a natural monopoly where the Long-Run Average Cost (LRAC) is continually falling over the entire range of market demand. If the government forces the firm to set a price equal to marginal cost to achieve allocative efficiency, what will be the result?

A natural monopoly is characterized by continuously falling long-run average costs (LRAC) across the entire range of market demand.

Discuss why allocative efficiency (where \(P = MC\)) would lead to the firm making a subnormal profit or loss without a government subsidy.

A firm in a contestable market currently earns supernormal profits. Evaluate the likely impact of the threat of 'hit-and-run' entry on the firm's choice between profit-maximising and limit-pricing strategies.

In an oligopolistic market, two major airlines are deciding whether to engage in a price war or to follow a price leadership model. The following payoff matrix shows the daily profits (\(\$000\)) for Airline A and Airline B:

Airline B High Price: (A: 500, B: 500)
Airline B Low Price: (A: 100, B: 700) [if A is High]
Airline A Low Price, Airline B High Price: (A: 700, B: 100)
Both Low Price: (A: 200, B: 200)

(a) Define interdependence and explain why these firms might be tempted to collude. (2)
(b) Use the principles of game theory to identify the likely outcome if both firms act independently to maximise their own profit. (2)

The market for domestic electricity is dominated by four large firms which account for \(85\%\) of total market share. These firms are considering whether to engage in price competition or collusion.

(a) Calculate the four-firm concentration ratio for this market and explain what this value indicates about the market structure. (2)
(b) Using the concept of interdependence and game theory, explain why firms in this market might prefer to engage in non-price competition rather than a price war. (3)
(c) Evaluate the impact of third-degree price discrimination by these electricity firms on both the firm's profits and consumer surplus. (3)