AQA A-level Economics: Dynamic competition and contestable markets (7136) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions follow the AQA AS and A-level Economics specification (version 1.3, 29 June 2022), A-level content for first teaching from September 2015: the dynamics of competition and contestable markets (4.1.5.8 and 4.1.5.9 in the PDF; 3.1.5.8 and 3.1.5.9 on the AQA website). All firms, countries and figures are invented. Study first with the study guide and the revision notes. The AQA A-level Economics hub and the printable checklist list the rest of the course.

Questions

1. Define non-price competition and give two examples. [3]

2. Firm Delta sells lamps for 27 each. Variable cost per lamp is 18. A marketing campaign costs 31,500.

(a) Calculate the number of extra lamps Delta must sell to break even on the campaign. [2] (b) The campaign adds 4,200 lamps. Calculate the net gain. [2]

3. Explain one short-run benefit and one long-run benefit of competition. [4]

4. Kettle K costs 45 and lasts 5 years. Kettle L costs 28 and lasts 2.5 years. Calculate the cost per year of each and explain why the maker of K might stress durability rather than cut its price. [4]

5. In an invented market for meal kits in Country B, one firm (Tamsin) sells 30,000 boxes a month at 25 with an average cost of 17. A new firm (Pellet) enters with a cheaper delivery system. The market price falls to 21. Tamsin sells 26,000 boxes and Pellet 14,000, and Tamsin’s average cost is unchanged.

(a) Calculate the percentage change in Tamsin’s profit. [3] (b) Explain how the data illustrate creative destruction. [3]

6. An entrant’s total entry cost is 180,000, of which 25% can be recovered on leaving. Calculate the sunk cost and explain why it affects how contestable the market is. [4]

7. In the same market, the entrant expects to sell 3,000 units a month at a price of 8.40 with a unit cost of 7.20, for nine months before the incumbent responds. The sunk cost is 135,000.

(a) Calculate the net gain or loss from a nine-month hit-and-run entry. [4] (b) The sunk cost falls to 10% of 180,000. Calculate the new net gain or loss. [2]

8. State two features of a perfectly contestable market and explain why a market with one seller might still keep price close to average cost. [4]

9. Evaluate whether profits earned by a firm with monopoly power will always be competed away over time. [9]

10. In Country C an incumbent can sell 6,000 units a month at 22 with an average cost of 13, or 9,000 units at 16 with an average cost of 12.50. A would-be entrant has an average cost of 17.

(a) Calculate the incumbent’s monthly profit at each price and the percentage change in profit if it moves to the lower price. [4] (b) Explain why the incumbent might choose the lower price. [3] (c) If the incumbent keeps its price at 22, an entrant could sell 3,000 units a month at 19 with a unit cost of 14 for six months, with an entry cost of 200,000. Evaluate whether entry is likely if 30% of the entry cost can be recovered, and if 85% can be recovered. [5]

11. Explain two ways in which technological change can lead to creative destruction. [4]

Answers

1. Non-price competition is rivalry between firms based on something other than a lower price [1], such as product quality or design [1], branding, after-sales service, delivery speed or cost reduction [1]. [3] Examiner insight: A definition that says only “not about price” tends to earn less than one that names what firms compete on; give two distinct examples, not two wordings of one.

2. (a) Margin per lamp = 27 - 18 = 9 [1]. Break-even = 31,500 / 9 = 3,500 lamps [1]. (b) Extra margin = 4,200 x 9 = 37,800 [1]. Net gain = 37,800 - 31,500 = 6,300 [1]. [4] Examiner insight: Show the margin before dividing; working that is set out step by step lets a reader see your method even if one figure slips. Give units or a currency symbol when the question does.

3. Short run: competing firms undercut each other, so price falls for consumers [1], because a firm charging more than rivals loses sales [1]. Long run: firms have time to invest in research and new processes [1], which lowers unit costs and improves products over time, benefits that last [1]. [4] Examiner insight: Questions that separate short and long run reward an answer that places each benefit in the right time frame and explains the mechanism, not a list of benefits.

4. K: 45 / 5 = 9 a year [1]. L: 28 / 2.5 = 11.20 a year [1]. K is cheaper per year of use by 2.20 [1]. The maker of K can compete on quality and durability, keeping a higher sticker price and avoiding a price war that rivals would copy quickly [1]. [4] Examiner insight: Answers that compare the two per-year figures and then link to the firm’s choice gain more than answers that stop at the calculation.

5. (a) Profit before = (25 - 17) x 30,000 = 240,000 [1]. Profit after = (21 - 17) x 26,000 = 104,000 [1]. Change = (104,000 - 240,000) / 240,000 = -56.7% [1]. (b) A new entrant with a cheaper delivery system entered the market [1]. The incumbent’s profit and market share fell and price fell for consumers [1]. Consumer spending rose from 750,000 to 840,000 (a rise of 12%) as more boxes were sold: the new firm created new sales as the old firm’s position was destroyed [1]. [6] Examiner insight: In a percentage-change calculation, divide by the original figure. In the explanation, tie each point to a number from the data rather than defining the term in general.

6. Recoverable = 180,000 x 0.25 = 45,000 [1]. Sunk cost = 180,000 - 45,000 = 135,000 [1]. Money that cannot be got back on leaving makes entry a bigger gamble [1]. The higher the sunk costs, the less contestable the market, as entrants fear a loss if they fail [1]. [4] Examiner insight: Be clear which part is sunk. A common slip is to treat the recoverable share as the sunk cost.

7. (a) Monthly profit = 3,000 x (8.40 - 7.20) = 3,600 [1]. Nine months = 32,400 [1]. Net = 32,400 - 135,000 = -102,600 [1]. A loss, so the hit-and-run entry does not pay [1]. (b) New sunk cost = 180,000 x 0.10 = 18,000 [1]. Net = 32,400 - 18,000 = +14,400 [1]. [6] Examiner insight: State the decision as well as the figure; the conclusion shows you understand what the number means for the entrant.

8. Any two of: free entry [1], free exit or no sunk costs [1]. Even one seller faces the threat that a rival will enter and take any supernormal profit [1], so it keeps price close to average cost and earns about normal profit [1]. [4] Examiner insight: The link between the threat of entry and the incumbent’s pricing is what shows understanding; features listed with no link usually earn only part of the credit.

9. Chain: monopoly power gives large profit [1], which gives an incentive for new firms to enter and innovate [1], overcoming barriers, so the incumbent loses sales and the profit falls: creative destruction [1]. Application: the process is stronger where barriers are low and sunk costs small, or where entrants have access to finance [1], and it may be weaker if the incumbent holds patents or raises sunk costs through advertising or contracts [1]. Evaluation: it can take years, during which consumers pay high prices [1]; the incumbent may buy or copy the rival [1]; the entrant may itself become dominant, so profits move rather than disappear [1]. Judgement: profits are not always competed away, and the speed depends on the height of barriers and the pace of technological change [1]. [9] Examiner insight: The strongest answers argue a line from start to end and reach a reasoned judgement, rather than listing points for and against; say what the outcome depends on.

10. (a) Profit at 22 = (22 - 13) x 6,000 = 54,000 [1]. Profit at 16 = (16 - 12.50) x 9,000 = 31,500 [1]. Change = (31,500 - 54,000) / 54,000 = -41.7% [1]. The answer is a fall in profit [1]. (b) The entrant’s cost is 17, so at 16 it cannot compete profitably [1]. At 22 it could undercut and profit, so the incumbent risks losing sales [1]. A lower price secures lasting but smaller profit and deters entry [1]. (c) Entrant’s monthly profit = 3,000 x (19 - 14) = 15,000 [1]. Six months = 90,000 [1]. If 30% recoverable, sunk = 140,000, net = -50,000, so entry is unlikely [1]. If 85% recoverable, sunk = 30,000, net = +60,000, so hit-and-run entry is likely [1]. Judgement: high sunk costs protect the incumbent, so contestability depends on them [1]. [12] Examiner insight: In a longer data question, set out each calculation separately and then use the results in the evaluation; conclusions that cite the figures are easier to credit than general statements.

11. First, a new technology can make an existing product obsolete [1], so sales and jobs in the old industry fall while the new product creates a new market [1]. Second, a technology can lower costs or open a new way to reach customers [1], helping an entrant overcome the barriers that protected the incumbent and take its market share [1]. [4] Examiner insight: Each way needs a developed link from technology to the market outcome; naming a technology without the effect on incumbent and entrant tends to earn little.

Where marks are usually lost

• Using the new figure as the base in a percentage change.
• Treating the recoverable share of an entry cost as the sunk cost.
• Writing that creative destruction only closes firms, without the new products and entry.
• Listing features of a contestable market without linking them to the incumbent’s behaviour.
• Giving benefits of competition without saying whether they are short run or long run.
• Giving a calculation with no working, units or conclusion.
• Describing non-price competition with no effect on revenue, cost or market share.
• Ending an evaluation without a judgement or without saying what the answer depends on.

Next steps

• Re-read the revision notes and the study guide.
• Tick off progress on the printable checklist and browse the AQA A-level Economics hub.
• Try the free 10-minute diagnostics to find weak topics.
• Book a free trial class.

Official syllabus

AQA AS and A-level Economics specification (7135 and 7136), version 1.3, 29 June 2022, published by AQA; A-level content for first teaching from September 2015. Sub-sections 4.1.5.8 and 4.1.5.9 in the PDF (3.1.5.8 and 3.1.5.9 on the AQA website).