Pearson Edexcel International Advanced Level Economics: Oligopoly and collusion (YEC11) – 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 oligopoly, interdependence, collusion and price and non-price competition: section 3.3.3 item 5, points a to g, of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11) specification, Issue 2, June 2018. The specification labels Unit 3, Business behaviour, an IAL compulsory unit (the extra International A2 content, for the full International Advanced Level only). All firms and figures are invented. Learn the content first in the study guide or the revision notes. See also the course hub and the checklist.

Questions

1. State three assumptions of oligopoly. [3]

2. Explain how economies of scale and sunk costs each act as a barrier in an oligopoly. [4]

3. Firms C and D each choose to hold price or cut price. Profits in millions are (C, D).

	D holds	D cuts
C holds	(18, 18)	(6, 26)
C cuts	(26, 6)	(12, 12)

(a) Identify C’s dominant strategy, with reasons. [2] (b) State the likely outcome and explain why it is not the best joint result. [3] (c) Explain why co-operation may be easier to sustain if the game is repeated. [2]

4. Market demand is P = 130 − Q. Two firms form a cartel and each has constant marginal cost of 30.

(a) Calculate the profit-maximising cartel output and price, and each firm’s profit if output is shared equally. [4] (b) One firm secretly raises output to 35 while the other keeps to 25. Calculate its profit and compare. [3] (c) Explain what this shows about the stability of a cartel. [2]

5. Explain how price leadership operates and why it may avoid a price war. [4]

6. Price is 20 and a firm sells 5,000 units. Market demand has price elasticity of demand of −0.6. The firm cuts price by 8% and its rivals match.

(a) Calculate the percentage change in quantity and the new quantity. [2] (b) Calculate the change in the firm’s revenue. [3] (c) Explain what this suggests about price wars when demand is inelastic. [2]

7. A dominant firm has average cost of 12 and sells 300 units a period. It cuts price to 9 to drive out a rival. The war lasts 4 periods, then price rises to 16.

(a) Calculate the loss per period and the total loss. [2] (b) Calculate the profit per period after the rival leaves and the number of periods needed to recover the loss. [2] (c) Explain two reasons why the strategy might fail. [2]

8. An incumbent has average cost of 10 at 200 units. A possible entrant would have average cost of 16 at 30 units. The current price is 22.

(a) Calculate the entrant’s profit at a price of 22 and at a price of 14. [2] (b) Explain why 14 is a limit price and what it costs the incumbent. [3]

9. Explain two costs and one benefit of collusion, naming the stakeholder affected in each case. [6]

10. (a) Explain two forms of non-price competition other than advertising. [4] (b) An advertising campaign costs 1.8 million. Each extra unit sold adds 5 to profit before the campaign cost. Current sales are 1,200,000 units. Calculate the extra sales needed to break even and express them as a percentage of current sales. [3]

11. Evaluate whether non-price competition benefits consumers more than price competition in an oligopoly. [10]

Answers

1. Any three: a few large firms hold most of the market [1]; there are significant barriers to entry [1]; firms are interdependent, so each must consider rivals’ reactions [1]. Also acceptable: price makers, identical or differentiated products. [3] Examiner insight: Stating “few firms” alone is thin; adding what it means for behaviour usually shows understanding.

2. Economies of scale: large incumbents have lower average cost [1], so a small entrant cannot match their price profitably [1]. Sunk costs: spending such as specialised equipment cannot be recovered on exit [1], so entry is risky and firms stay longer or never enter [1]. [4] Examiner insight: A definition of the barrier gains less than the chain from the barrier to the entrant’s decision.

3. (a) If D holds, C earns 26 by cutting against 18 by holding [1]; if D cuts, C earns 12 by cutting against 6 by holding. Cutting is best either way, so it is dominant [1]. (b) The game is symmetrical, so both cut and the outcome is (12, 12) [1]. Total profit is 24, against 36 if both hold [1]. Each firm has an incentive to cut if the other holds, so (18, 18) is not stable [1]. (c) In a repeated game a firm that cuts can be punished in later rounds [1], so the short-term gain may be outweighed by lost future profit [1]. [7] Examiner insight: Show the best reply for each rival choice before naming the dominant strategy, rather than only the final matrix cell.

4. (a) MR = 130 − 2Q = 30 [1], so Q = 50 [1] and P = 130 − 50 = 80 [1]. Total profit = (80 − 30) × 50 = 2,500, so 1,250 each [1]. (b) Total output = 35 + 25 = 60 and P = 130 − 60 = 70 [1]. Profit = (70 − 30) × 35 = 1,400 [1], which is more than 1,250 [1]. (c) Each member can gain by cheating [1]. If both cheat, price falls towards 30 and the cartel breaks down [1]. [9] Examiner insight: Show the steps (MR equal to MC, then price from demand, then profit): a clear method lets the reader see your reasoning even if a number slips.

5. One firm, often the largest, sets the price [1] and others follow it [1]. Rivals expect any undercutting to be matched, so there is little to gain from it [1]. Price stays stable and a price war is avoided without a formal agreement [1]. [4] Examiner insight: Naming dominant or barometric leadership helps only if you also explain why followers choose to follow.

6. (a) Quantity change = 0.6 × 8% = 4.8% [1]; new quantity = 5,000 × 1.048 = 5,240 [1]. (b) Revenue before = 20 × 5,000 = 100,000 [1]. New price = 20 × 0.92 = 18.40, so revenue after = 18.40 × 5,240 = 96,416 [1]. Revenue falls by 3,584 [1]. (c) Demand is inelastic, so the rise in quantity is proportionally smaller than the fall in price [1]. With rivals matching, no firm gains share, so a price war lowers revenue for everyone [1]. [7] Examiner insight: Use the elasticity value in the working; an answer that only says “revenue falls” does not show how it was reached.

7. (a) Loss per period = (9 − 12) × 300 = −900, a loss of 900 [1]. Over 4 periods the loss is 3,600 [1]. (b) Profit after the rival leaves = (16 − 12) × 300 = 1,200 a period [1]. Periods to recover = 3,600 ÷ 1,200 = 3 [1]. (c) Any two: the rival may not leave, for example if it has funds to survive [1]; new firms may enter when price rises [1]; competition authorities may act against predatory pricing. [6] Examiner insight: Commenting on the length of recovery relative to the length of the war strengthens an evaluation of whether the strategy pays.

8. (a) At 22: (22 − 16) × 30 = 180 [1]. At 14: (14 − 16) × 30 = −60 [1]. (b) At 14 the entrant makes a loss, so it is deterred [1], while 14 is still above the incumbent’s average cost of 10, so it earns 4 per unit [1]. The cost is the lower margin: 4 per unit instead of 12 at a price of 22 [1]. [5] Examiner insight: A limit price sits between the two firms’ costs; saying it is “low” without that comparison is incomplete.

9. Consumers: higher prices and less choice [1] because competition is restricted and output falls [1]. Government: costs of detecting and prosecuting collusion [1], and reduced welfare [1]. Benefit to producers: higher and more stable profit [1], because uncertainty over rivals’ actions falls [1]. Other valid stakeholders include workers. [6] Examiner insight: Answers that name the stakeholder and then give a reasoned effect tend to do better than lists of costs and benefits.

10. (a) Quality: better design or reliability [1] supports loyalty or a higher price [1]. After-sales service: warranties and repairs [1] encourage repeat purchase [1]. Endorsement or product placement are also valid. (b) Break-even extra sales = 1,800,000 ÷ 5 = 360,000 units [1] (campaign cost divided by extra profit per unit [1]). As a percentage of current sales: 360,000 ÷ 1,200,000 = 30% [1]. [7] Examiner insight: Giving the unit with the answer and a comment on whether 30% is realistic usually adds to a calculation.

11. For non-price competition: consumers gain wider choice, better quality and service [1]; firms avoid costly price wars, which can protect investment and jobs [1]; loyalty may create stable supply and better information [1]. Against: spending on advertising can be wasteful and raise prices [1]; brand loyalty can create barriers to entry, so less competition over time [1]. For price competition: lower prices raise consumer surplus at once [1]; but a war can squeeze margins, cutting quality, jobs and supplier prices [1], and may drive out smaller firms, leaving fewer sellers [1]. Evaluation: the answer depends on elasticity, the time horizon and whether rivals can copy [1]. Judgement: non-price competition usually gives more lasting benefits when markets are stable, while price competition helps more when firms are colluding [1]. [10] Examiner insight: A balanced list of points is weaker than a judgement that is supported and says which conditions would change it.

Where marks are usually lost

• Listing assumptions without linking them to interdependence
• Naming the dominant strategy without checking each rival choice
• Treating the cartel outcome as stable
• Forgetting to share cartel output between firms before calculating profit each
• Not using the elasticity value when judging a price cut
• Confusing predatory pricing with limit pricing
• Giving costs and benefits without naming the stakeholder
• Evaluation with no judgement or no condition

Next steps

• Review the revision notes and the study guide
• Course pages: hub and checklist
• Try all the free 10-minute diagnostics
• Book a free trial class

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11), Specification, Issue 2, June 2018, Pearson Education Limited: section 3.3.3, Market structures and contestability, item 5, Oligopoly (points a to g), in Unit 3, Business behaviour.