OCR A Level Economics: Contestable markets, integration and competition policy (H460) – Revision Notes

These notes condense the part of the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), that deals with contestable markets, integration, growth of firms, regulation, ownership, competition policy and interdependence. It sits within Market structures in Component 1, Microeconomics (H460/01). The specification labels no content as AS or Extension. Figures are invented and illustrative. For full explanations, read the study guide.

Related pages: the OCR Economics hub, the printable checklist, the practice questions, the Microeconomics revision notes and the free diagnostics.

Key definitions

Term	Meaning
Perfectly contestable market	Entry and exit are costless, so the threat of entry disciplines incumbents whatever their number
Sunk cost	Spending that cannot be recovered on leaving
Hit-and-run entry	Quick entry to capture supernormal profit, then exit once incumbents respond
Horizontal integration	Merger of rivals operating in one industry at one stage of the supply chain
Vertical integration	Joining firms at different stages; backward is towards suppliers, forward is towards customers
Conglomerate integration	Joining firms in unrelated industries
Organic growth	Growth by expanding existing operations
Price cap	A limit on price rises, often inflation minus an efficiency factor X
Competition policy	Policy to protect competition: merger control, action on cartels and abuse of power, market investigations, lowering barriers
Interdependence	One firm’s decisions affect rivals, and theirs affect it

Contestable markets: the logic chain

1. No sunk costs and free entry mean any supernormal profit attracts a hit-and-run entrant.
2. So price falls to average cost (AC): normal profit only.
3. Any cost above the minimum lets an entrant undercut, so the firm sits at minimum AC. This is productive efficiency.
4. At minimum AC, marginal cost (MC) equals AC, and price equals AC, so price equals MC. This is allocative efficiency.

Diagram reminder. U-shaped AC with MC through its lowest point; downward-sloping AR. The contestable point is where AR meets AC at its minimum. The unthreatened monopolist sits higher on AR, where MR = MC, with a profit rectangle.

	Unthreatened monopolist	Perfectly contestable
Price	Above AC	Equal to AC and MC
Profit	Supernormal	Normal
Cost	Possibly above minimum	Minimum AC
Welfare	Deadweight loss	None

Caveat. If scale economies continue beyond the size of the market, one firm survives with price equal to AC but above MC. Allocative efficiency is then only approximate.

Advantages: lower prices, cost discipline, no need for break-up, normal profit only. Disadvantages: zero sunk costs are rare; firms under-invest in sunk capital and research; unreliable hit-and-run suppliers; instability of jobs and supply.

Contribution of the theory (evaluate): shifts focus to barriers and sunk costs; gives a benchmark; supports policy that lowers barriers. Limits: real markets have sunk costs, incumbents respond with strategic pricing, information is imperfect, and contestability is a matter of degree.

Method for a hit-and-run calculation.

1. Entrant profit per period = (entry price − AC) × quantity.
2. Multiply by the number of periods before the incumbent reacts.
3. Subtract any unrecoverable entry cost.
4. A positive result means entry is worthwhile; a negative one means sunk costs act as a barrier.

Integration

Type	Example (illustrative)	Main motive
Horizontal	Two shoe makers merge	Scale economies, market power
Vertical backward	Shoe maker buys leather supplier	Secure supply, capture margin
Vertical forward	Shoe maker buys shops	Control distribution
Conglomerate	Shoe maker buys a toy maker	Risk spreading

Evaluating integration by agent.

Agent	Gains	Losses
Firms and shareholders	Scale economies, power, security	Integration cost, diseconomies, overpaying
Consumers	Lower costs passed on, range	Higher prices if rivals are weak
Workers	Larger career structure	Redundancies
Suppliers	Larger orders	Contracts lost

Judge by market share, remaining rivals, contestability and whether savings are passed on.

Reminder calculation. Firm P makes 20,000 units at AC £5 and firm R makes 30,000 at AC £6. Combined old cost: 100,000 + 180,000 = £280,000. Merged output of 50,000 at AC £5 costs £250,000, a saving of £30,000 or 10.7%.

Growth of firms

• Drivers: growth or sales objectives, scale economies, market power, rising demand, technology, export markets, available finance, managers’ incentives.
• Constraints: weak demand, strong rivals, finance limits, owners wanting control, diseconomies of scale, regulation and merger control.
• Organic versus external: organic keeps control but is slow; mergers are quick but riskier.

Method to split revenue growth. Revenue = market size × share. Compute revenue each year. Then compute next year’s market size at the old share to isolate market growth. The remainder is share gain.

Regulation and ownership

Ownership	Likely behaviour	Risk
Private, shareholder-owned	Profit focus, cost control	Principal-agent problems; short-termism
Public sector	Welfare or political targets	Weak cost discipline
Co-operative or social enterprise	Balance of profit and member or social aims	Limited capital

Regulation: price caps, quality standards, entry rules, profit controls. With a cap of inflation minus X, the permitted rise is inflation − X. The firm keeps savings beyond X, so it has an incentive to cut costs. Risks: information gaps, regulatory capture, falling quality or investment under a strict cap.

Competition policy

• Tools: merger control, action against cartels and abuse of market power, market investigations, lowering barriers.
• Impact on behaviour: deters collusion, shapes merger proposals, may force remedies such as divestment.
• Weaknesses: costly and slow, information gaps, penalties may be below the gains from breaking the rules.

Deterrence rule. Expected penalty = probability of detection × fine. Collusion is deterred only if this exceeds the total gain.

Interdependence: the evaluation points

• High in oligopoly (few firms, reactions matter); low in perfect competition and monopolistic competition.
• Even monopolies face potential entrants if the market is contestable.
• All firms are linked through suppliers, customers and labour markets.
• The answer depends on market definition and how long the period is.

Must-know distinctions

• Few barriers versus no sunk costs. A market can have no legal barriers yet still be uncontestable because entry needs specialised, unrecoverable spending.
• Market structure versus market behaviour. Contestability explains why a market with one firm can still produce low prices, so concentration alone is a poor guide.
• Organic growth versus merger. Organic growth adds capacity; a merger changes ownership of capacity that already exists.
• Backward versus forward. Backward integration moves towards the source of inputs, forward integration towards the customer.
• Regulation versus competition policy. Regulation sets rules for a particular industry, such as a price cap. Competition policy applies across industries to protect rivalry.
• Cost saving versus price cut. A merger can lower cost without lowering price. Ask whether competition forces the saving to be passed on.
• Deterrence versus punishment. A fine that is large in pounds may still be too small relative to the gain from collusion once the chance of detection is included.

Quick self-test

1. State three characteristics of a perfectly contestable market.
2. An entrant sells 500 units a week at £9 with AC £7. The incumbent reacts after two weeks and entry cost £2,500, all sunk. Calculate the net result.
3. Explain why a firm in a perfectly contestable market is productively efficient.
4. A supermarket buys a farm that supplies it. Name the type of integration.
5. A firm has 10% of a £50m market and then 12% of a £52m market. Calculate revenue growth.
6. Inflation is 5% and X is 3%. A regulated price is £25. Find the new permitted price.
7. Give two tools of competition policy.
8. A cartel would gain £10m in total. Detection probability is 0.25 and the fine is 8% of £50m turnover. Calculate the expected fine and the fine needed to deter.
9. Name one reason why a conglomerate merger may reduce risk.
10. Give one reason a monopoly may still behave competitively.

Answers

1. No barriers to entry or exit, no sunk costs, and entrants who can match incumbents’ technology and have good information (any three).
2. Weekly profit (9 − 7) × 500 = £1,000. Two weeks gives £2,000. Net: 2,000 − 2,500 = −£500, so entry is not worthwhile.
3. Any cost above the minimum lets an entrant undercut at a profit, so the firm must produce at minimum AC.
4. Vertical backward integration.
5. Revenue rises from £5.0m to £6.24m: growth 24.8%.
6. Permitted rise is 5 − 3 = 2%. New price: 25 × 1.02 = £25.50.
7. Merger control and action against cartels (or abuse of dominance, market investigations, lowering barriers).
8. Fine = 0.08 × 50 = £4m. Expected fine = 0.25 × 4 = £1m. To deter: 10 ÷ 0.25 = £40m, which is 80% of turnover.
9. Profits in unrelated markets are less likely to fall together, so overall profit is more stable.
10. The threat of hit-and-run entry, if the market is contestable, or the risk of regulation.

Where marks are usually lost

• Writing that a contestable market needs many firms.
• Calling barriers low when the point is sunk costs.
• Stating allocative efficiency without showing price equal to MC.
• Forgetting that cost savings from a merger may not reach consumers.
• Describing horizontal and vertical integration the wrong way round.
• Listing regulation and ownership effects without a judgement on which matters more.
• Writing about competition policy in general without saying how firms behave differently.
• Making a one-sided case on interdependence without market definition.

Official syllabus

OCR, A Level Economics (H460) specification, Version 3.0 (June 2026), first assessment 2021. Component 1, Microeconomics (H460/01).