4.1.5.5 Oligopoly Quiz: AQA Economics, Unit 1

The 20 questions

1. Oligopoly is characterised by:

   • Many small firms selling identical products, each of which is so small that its decisions have no effect on the decisions of its rivals
   • A single seller with no close substitutes, which faces no competition at all and can therefore set the price that maximises its profit
   • A few large firms that are interdependent when setting price and output
   • Freely available inputs and no barriers to entry, so that new firms can join the market whenever the existing firms are earning profit

2. A market has a four-firm concentration ratio (CR4) of 85%. This suggests:

   • Perfect competition, since the largest firms hold most of the market and so must be price takers facing many small rivals
   • Low concentration, with many small firms competing for customers on price and quality across the whole of the market in every period
   • High concentration, with the four largest firms holding most of the market
   • No interdependence, since concentration ratios measure only prices and say nothing about how firms react to each other's decisions

3. Collusive oligopoly is best described as:

   • A market in which a single firm sets all prices, and the other firms in the industry simply accept the prices it announces each period
   • Firms agreeing, openly or tacitly, to restrict competition on price or output
   • Firms competing only through product design with no price coordination
   • Firms competing aggressively on price with no agreements, so that each firm cuts its price whenever it expects a rival to do the same

4. The kinked demand curve model suggests that prices in oligopoly tend to be:

   • Sticky, because rivals match price cuts but do not match price rises
   • Set where price equals marginal cost for every firm, so that the market price moves to the efficient level without any rivalry at all
   • Highly volatile, because rivals always match every price change that a firm makes, so prices move up and down together very quickly
   • Permanently lower, because rivals always cut their own prices first

5. The kinked demand curve has a kink because:

   • Demand is perfectly inelastic at all prices below average cost
   • Demand is relatively elastic for price rises, as rivals do not follow, and relatively inelastic for price cuts, as rivals follow
   • The firm faces a horizontal demand curve below the market price
   • Demand is perfectly elastic at all prices above marginal cost

6. Price leadership in oligopoly means:

   • One dominant firm sets a price that the others then follow
   • All firms set prices independently with no reference to rivals
   • Firms agree to share profits equally with no price changes
   • Government sets the price in every oligopolistic market

7. A cartel is best described as:

   • A formal agreement between firms to coordinate price and output to maximise joint profit
   • A group of firms that compete on quality only, with no formal or informal agreement on price
   • A single firm that controls all prices in an industry
   • A government body that sets maximum prices in a market, with powers to fine any firm that charges a price above the level it has set

8. Which is a reason cartels tend to be unstable?

   • Individual members have an incentive to cheat by undercutting the agreed price
   • Cartel members never share information about their output, so each member is unsure how much its rivals are producing in the period
   • Cartels can only exist in perfectly competitive markets
   • Cartels only operate in markets where all firms have identical costs

9. Two firms can each charge £10 or £8. If both charge £10, each earns £100. If one charges £8 and the other £10, the £8 firm earns £150 and the other earns £40. If both charge £8, each earns £80. This is best described as a prisoner's dilemma because:

   • Both firms earn more by colluding at 8 than at 10
   • Each firm gains by undercutting, and both end up at £8 earning less than if both had kept £10
   • Each firm prefers 8 whatever the rival does, so both firms end up charging 10 because neither wishes to be the first to cut its price
   • Both firms earn the same profit at every price, so there is no incentive for either firm to change its price in any period at all

10. Non-price competition in oligopoly includes:

    • Price cuts matched immediately by every rival in the market, so that no firm gains any customers from the price reductions it makes
    • Price discrimination between identical customers
    • Advertising, branding and product development, which can avoid direct price wars
    • Agreed output quotas set by a regulator, which fix the number of units each firm may sell and so remove any scope for rivalry at all

11. Why might oligopolists prefer non-price competition to price competition?

    • Price wars can reduce profits for all firms, while advertising or product differences may win customers with less risk
    • Non-price competition is always illegal under competition law
    • Non-price competition always lowers costs more than price cuts do
    • Price competition is impossible in any oligopoly by definition

12. Barriers to entry commonly found in oligopoly include:

    • High capital costs, economies of scale and control of key inputs or patents
    • A large number of firms already operating in the market, which makes it easy for newcomers to find customers and win a share of sales
    • Government price controls that apply to every firm in the market
    • Free access to all distribution networks for new firms, which allows any entrant to reach customers in the same way that incumbents do

13. Interdependence in oligopoly means that:

    • A firm's profit depends on how its rivals react to its own decisions
    • Each firm's profit is unaffected by the decisions of its rivals
    • Each firm sets its output where its fixed costs are minimised, so that rivals' decisions do not influence its choice of output
    • All firms in the market are price takers, so that each firm accepts the market price and can sell as much as it likes at that price

14. Why is uncertainty important in oligopoly decisions?

    • Firms cannot be sure how rivals will respond, making pricing and investment decisions risky
    • Uncertainty makes all oligopolies collude automatically
    • Firms always know their rivals' responses with certainty in every market
    • Uncertainty only affects firms under perfect competition

15. A price war in an oligopoly will most likely lead to:

    • A permanent monopoly as the weakest firm is absorbed
    • Lower prices and lower profits for the firms involved
    • Higher prices, since firms raise prices to recover losses
    • No change in profit, since all firms match price cuts exactly

16. Oligopoly can be defined in terms of:

    • The number of employees in each firm in the industry
    • The government's decision to set prices in the industry, which determines whether firms are treated as an oligopoly in law and practice
    • The seasonal demand for the product in the market, since oligopolies are defined by the timing of sales across the year
    • Market structure (few firms) or market conduct (interdependent behaviour)

17. Which is a possible advantage of oligopoly for consumers?

    • No variety of products or quality improvements
    • Guaranteed low prices because rivals always collude, which means that consumers pay the lowest price the cartel can agree on each year
    • Economies of scale and large investment in research can lower costs and improve products
    • Permanently higher prices than in any competitive market, since the large firms in the market always charge a price set well above cost

18. A firm in oligopoly invests heavily in research. Which factor is most likely to influence this decision?

    • A guarantee that rivals will not respond to new products, so the firm can be certain that any innovation will go unanswered by others
    • A government order to lower the price of the firm's output, which forces the firm to find cheaper ways of producing its goods
    • An automatic reduction of fixed costs in every market, which means that research spending always pays for itself in the first year
    • A desire to protect market share and create barriers to entry through innovation

19. Explain why collusion may allow oligopolists to act like a monopolist.

    • By charging the perfectly competitive price to maximise consumer surplus
    • By increasing output to force rivals out of the market
    • By jointly restricting output and setting a higher price, they can maximise joint profit as a single monopolist would
    • By forming a monopsony in the labour market, so that the firms can cut wages and recover the profits they lose in the product market

20. Concentration ratios are calculated by:

    • Subtracting the smallest firm's share from the largest firm's share, which shows how far apart the leader and the smallest firm are
    • Adding together the market shares of the largest firms in an industry
    • Multiplying the average price by the number of consumers in the market, giving an estimate of the total value of the industry each year
    • Dividing total costs by total revenue for the largest firm in the industry

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