AQA A-level Economics: Oligopoly: interdependence, collusion and kinked demand (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 cover the Oligopoly sub-section of the AQA A-level Economics specification (7136, version 1.3), numbered 3.1.5.5 on the AQA website and 4.1.5.5 in the combined PDF. All markets, firms and figures are invented. Read the study guide and revision notes first. See also the course hub, the checklist and the free diagnostics.

Questions

1. The table shows annual sales (£ million) in Country A’s market for tinned fish (invented): Firm 1: 120, Firm 2: 90, Firm 3: 60, Firm 4: 45, Firm 5: 35, Firm 6: 30, Firm 7: 20.

(a) Calculate the three-firm concentration ratio. [2] (b) Firms 3 and 4 merge. Calculate the new three-firm concentration ratio. [2] (c) Explain one limitation of using a concentration ratio to judge competition. [2]

2. Distinguish between defining oligopoly by market structure and by market conduct. [4]

3. Explain the difference between:

(a) collusive and non-collusive oligopoly [2] (b) cooperation and collusion between firms [2]

4. A firm in an oligopoly faces demand P = 26 − 0.1Q above the current price and P = 44 − 0.4Q below it (P in £, Q in units).

(a) Show that both curves give a price of £20 at an output of 60, and calculate the price elasticity of demand on each side of that point. [3] (b) Calculate marginal revenue on each side at an output of 60. [2] (c) Calculate the change in revenue if the firm raises its price to £24 and rivals do not follow, and if it cuts price to £17 and rivals match. [4] (d) Explain why a rise in marginal cost from £5 to £12 leaves price unchanged. [3]

5.

(a) Explain how the kinked demand curve illustrates interdependence between firms. [3] (b) Explain two limitations of the kinked demand curve model. [4]

6. Two firms form a cartel in a market with demand P = 140 − Q (P in £, Q in thousand units). Each has constant marginal cost of £20.

(a) Calculate the price, output and joint profit that maximise their combined profit. [4] (b) Calculate each firm’s profit under the agreement, and if both instead charge £60 and share demand equally. [2] (c) Firm A secretly cuts to £60 and wins 60 thousand of the 80 thousand units demanded, leaving Firm B with 20 thousand. Calculate each firm’s profit and explain what this suggests about cartel stability. [3]

7. Explain what is meant by price leadership, and distinguish between dominant-firm and barometric leadership. [4]

8. A bakery chain in an oligopolistic market spends £9 million on advertising, earns £150 million revenue and sells 3 million units.

(a) Calculate advertising as a percentage of revenue and advertising spending per unit sold. [2] (b) Explain two reasons why firms in oligopoly use non-price competition. [4]

9. Analyse the likely effects of a price war on consumers and on firms in an oligopoly. [6]

10. In a market for bulk salt in Country B (invented), four firms hold 90% of sales, the product is identical across firms, costs are similar, demand is stable and start-up costs are very high. Evaluate whether collusion is likely in this market. [9]

11. Evaluate the view that oligopoly benefits consumers. [12]

Answers

1. (a) Total sales = 120 + 90 + 60 + 45 + 35 + 30 + 20 = £400 million [1]. CR3 = (120 + 90 + 60) / 400 = 67.5% [1] [2] (b) The merged firm sells 60 + 45 = £105 million [1]. New CR3 = (120 + 105 + 90) / 400 = 315 / 400 = 78.75% [1] [2] (c) It hides the split of shares within the top group, or ignores imports and the market definition [1]. So a high ratio can sit alongside strong rivalry, or a low one alongside local dominance [1] [2] Examiner insight: Show the sum of the top three before dividing; a visible method is easier to credit than a bare percentage. A limitation should say what the ratio leaves out, not merely that it is “inaccurate”.

2. Structure: a market with a small number of large firms holding most of the market [1], with barriers to entry and a high level of concentration [1]. Conduct: firms behave interdependently, taking account of rivals’ likely reactions [1], for example by colluding, matching or leading price changes [1] [4] Examiner insight: A strong answer gives both definitions and shows that they can diverge, for instance a concentrated market that is fiercely competitive. Writing only “few firms” for both parts earns little.

3. (a) Collusive: firms coordinate to limit competition, openly or tacitly [1]. Non-collusive: firms compete and decide independently while watching rivals [1] [2] (b) Cooperation: joint action that does not restrict competition, such as a shared safety standard [1]. Collusion: an agreement or understanding that restricts competition, for example fixing prices [1] [2] Examiner insight: The contrast has to appear within each part; two separate definitions with no comparison leave the distinction implied. The test is the effect on competition.

4. (a) Above: 26 − 0.1 × 60 = 20 [1]. Below: 44 − 0.4 × 60 = 20. PED above = −10 × (20 / 60) = −3.33 (elastic) and PED below = −2.5 × (20 / 60) = −0.83 (inelastic) [1] [1] [3] (b) MR above = 26 − 0.2 × 60 = 14 [1]. MR below = 44 − 0.8 × 60 = −4 [1] [2] (c) Original revenue = 20 × 60 = £1,200. Rise to £24: Q = (26 − 24) / 0.1 = 20 [1], revenue = £480, a fall of £720 [1]. Cut to £17: Q = (44 − 17) / 0.4 = 67.5 [1], revenue = £1,147.50, a fall of £52.50 [1] [4] (d) The marginal revenue curve has a vertical gap at output 60, from −4 to 14 [1]. Marginal costs of £5 and £12 both lie inside it, so MC = MR at output 60 in each case [1]. Price is read from the demand curve at that output, so stays at £20 [1] [3] Examiner insight: State which side of the kink each elasticity belongs to, and say what the sign and size mean. In (d), point to the gap in marginal revenue rather than just repeating that rivals will not follow.

5. (a) A firm raising price expects rivals not to follow, so it loses customers [1]. A firm cutting price expects rivals to match, so it gains few [1]. Each firm’s best decision depends on rivals’ reactions, so price tends to stay at the kink [1] [3] (b) It does not explain how the original price was set [1], so it describes price stability rather than price determination [1]. It ignores collusion, entry or non-price competition [1], and firms may follow price rises when costs rise for all [1] [4] Examiner insight: The specification presents this model as an illustration of interdependence and not as a complete theory of oligopoly. Tie each limitation to a consequence; a list of labels reads as thin.

6. (a) MR = 140 − 2Q [1]. Set MR = MC: 140 − 2Q = 20, so Q = 60 thousand [1]. P = 140 − 60 = £80 [1]. Joint profit = (80 − 20) × 60 = £3,600 thousand [1] [4] (b) Under the agreement each earns 3,600 / 2 = £1,800 thousand [1]. At £60, Q = 80, so each sells 40 and earns (60 − 20) × 40 = £1,600 thousand [1] [2] (c) A earns (60 − 20) × 60 = £2,400 thousand [1], B earns 40 × 20 = £800 thousand [1]. A gains from cheating and B loses, so firms have an incentive to cheat, and retaliation would erode the cartel’s profit [1] [3] Examiner insight: Set marginal revenue equal to marginal cost on the market curve, not on one firm’s share. State units (£ thousand) with the final answers.

7. Price leadership is when one firm changes price and the others follow, usually without a formal agreement [1]. Dominant-firm leadership: the largest or lowest-cost firm sets the price [1]. Barometric leadership: a firm that reads the market well moves first and others follow because it reflects costs and demand [1]. Followers avoid the uncertainty of an unmatched move, which is a form of tacit coordination [1] [4] Examiner insight: Distinguish the two types by why rivals follow, not just by the label. Adding a short reason for following lifts a definition into an explanation.

8. (a) 9 / 150 = 6% [1]; 9 / 3 = £3 per unit [1] [2] (b) Price cuts are quickly copied, so they cut everyone’s profit and risk a price war [1], whereas a new brand image or service is harder to match [1]. Branding builds loyalty and makes demand less elastic [1], which allows the firm to protect its margin [1] [4] Examiner insight: Each reason needs a link to oligopoly itself, such as rivals’ reactions. A reason that would fit any firm, such as “to increase sales”, is hard to reward.

9. Consumers gain lower prices in the short run [1]. Greater volume may be affordable for more buyers [1]. If weaker rivals exit, prices may later rise [1]. Firms see falling margins and profit [1], so they may cut investment and research [1]. Smaller or higher-cost firms may leave, raising concentration [1] [6] Examiner insight: Separate the short-run and long-run effects, and give both groups. A one-sided answer, for example only “lower prices”, gains less.

10. Favouring collusion: a high four-firm concentration ratio of 90% means few firms to coordinate [1]. An identical product makes prices easy to compare and monitor [1]. Similar costs make an agreed price suit all firms [1]. Stable demand reduces pressure to cut price [1]. High start-up costs keep entrants out [1]. Against: each firm still gains by secret cutting [1]; competition authorities may detect and fine cartels [1]; powerful buyers may resist [1]. Judgement: collusion is likely given the structure, but how long it lasts depends on monitoring and enforcement [1] [9] Examiner insight: Use the details in the context: each feature should be linked to collusion. A final judgement must pick a side and justify it from the evidence given.

11. Benefits: economies of scale can lower costs and prices [1]. Supernormal profit can fund investment and research [1], producing new products [1]. Non-price competition raises quality and variety [1]. Price stability helps planning [1]. Drawbacks: with barriers to entry, prices can be higher and output lower than in competition [1]. Collusion directly harms consumers [1]. Weak competition may reduce efficiency [1]. Heavy advertising raises costs [1]. Evaluation: the outcome depends on how much profit is reinvested [1], how strong rivalry and regulation are [1], and the time period considered. A reasoned conclusion weighs these [1] [12] Examiner insight: Build chains of reasoning, for example barriers, then profit, then research, then new products, and then say when the chain fails. Balanced lists with no conclusion leave the evaluation incomplete.

Where marks are usually lost

• Dividing by the wrong total when finding a concentration ratio.
• Adding a single firm’s share instead of the n largest.
• Placing the elastic section below the kink instead of above.
• Treating the kinked demand curve as the whole theory of oligopoly.
• Leaving out units, such as £ thousand or percentages.
• Confusing cooperation with collusion.
• Describing a cartel without explaining why it may fail.
• Listing advantages and disadvantages without using the context or reaching a judgement.

Next steps

• Revise with the revision notes and return to the study guide.
• Tick off the topic on the checklist and see the course hub.
• Try all the free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

AQA, AS and A-level Economics specification (7135 and 7136), version 1.3, 29 June 2022, first teaching from September 2015.