Market structures

Step 1. Calculate each market share. Share = firm sales / total market sales x 100. Firm A: 260/800 = 32.5%. Firm B: 180/800 = 22.5%. Firm C: 100/800 = 12.5%. Firm D: 60/800 = 7.5%.

Step 2. Add them for the concentration ratio. 32.5 + 22.5 + 12.5 + 7.5 = 75%. The four-firm concentration ratio is 75%.

Step 3. Interpret the figure. Three quarters of the market is held by four firms, leaving 25% shared among all the others. This is a concentrated market, consistent with oligopoly, where firms are few enough that each must consider how rivals will respond to its decisions.

Step 4. State what the ratio does not tell you. It says nothing about how the share is distributed among the four, so a market with one firm at 70% looks the same as four firms at 18.75% each despite being very different. It also ignores whether entry is easy: a concentrated market that newcomers can enter freely may behave competitively.

Step 4 is where the evaluation marks are. A concentration ratio measures structure, not conduct, and a high ratio is evidence of possible market power rather than proof of its abuse.

Step 1. Calculate the loss if it produces. Total revenue = $12 x 100 = $1,200. Total cost = $15 x 100 = $1,500. The firm makes a loss of $300.

Step 2. Calculate the loss if it shuts down. Fixed cost = (ATC - AVC) x output = ($15 - $10) x 100 = $500. If it produces nothing it still pays this, so the loss from shutting down is $500.

Step 3. Decide for the short run. Producing loses $300 and shutting down loses $500, so it should keep producing. The reason is that price ($12) is above AVC ($10): each unit covers its variable cost and contributes $2 towards fixed costs, $200 in total, which cuts the loss from $500 to $300.

Step 4. Find the price at which it would shut down now. The short-run shutdown price is the minimum of AVC, $9.50. Below that, producing would lose more than the $500 of fixed costs.

Step 5. Decide for the long run. The price of $12 is below the minimum of ATC, $14, so the firm cannot cover all its costs at any output. If the price stays at $12 it should leave the industry in the long run. As firms like it leave, industry supply falls and the price rises towards $14, where the remaining firms earn normal profit.

The distinction examiners test is between shutting down now and leaving the industry. A firm making a loss is not necessarily about to close: the test in the short run is AVC, not ATC.

Step 1. Firm A's best response if B charges high. A earns $10m by charging high and $14m by charging low, so A should charge low.

Step 2. Firm A's best response if B charges low. A earns $2m by charging high and $5m by charging low, so A should still charge low. Low is better for A whatever B does, so it is A's dominant strategy.

Step 3. Firm B's best responses. The matrix is symmetrical, so the same reasoning applies: low price is B's dominant strategy.

Step 4. Identify the equilibrium. Both charge low and earn $5m each. Neither can gain by changing its own choice alone, since switching to high while the other stays low would cut its profit to $2m. This is the Nash equilibrium.

Step 5. Explain the dilemma and the incentive to collude. If both charged high they would earn $10m each, double the equilibrium profit. Each firm acting in its own interest produces an outcome worse for both. That gap is the incentive to collude and agree to keep prices high.

Step 6. Explain why collusion is unstable. Even after agreeing to charge high, each firm can raise its profit from $10m to $14m by secretly cutting its price. The same incentive that creates the dilemma threatens any agreement to escape it.

Always check each player's best response to each of the other player's choices, one at a time. Candidates who compare totals across the matrix, or pick the cell with the highest combined profit, have not used game theory.

G, D, C, F, A, B, E

1. The monopolist faces a downward-sloping demand curve, so selling an extra unit requires cutting price on all units.
2. Marginal revenue is therefore below average revenue at every output.
3. Profit is maximised where MC equals MR, and since MR lies below AR, price at that output exceeds marginal cost.
4. Price measures the value consumers place on the last unit; marginal cost measures the resources used producing it.
5. Price above marginal cost means consumers value additional units by more than they cost society to produce.
6. Those units are nonetheless not produced, because producing them would reduce the monopolist's profit.
7. The welfare gain forgone on those unproduced units is the deadweight loss, and it exists because the monopolist maximises profit rather than welfare.

Step 6 is the one to state explicitly. The monopolist is not behaving irrationally or malevolently; the misallocation follows from profit maximisation under a downward-sloping demand curve. That framing is what examiners mean by economic analysis rather than assertion.

C, E, D, A, F, G, B

1. Firms in an oligopoly recognise that competing on price drives them all towards the low-profit outcome.
2. They agree, formally in a cartel or tacitly, to restrict output and raise price towards the level a monopolist would choose.
3. Joint profit rises, but at the agreed high price each member could sell more if it cut its own price slightly.
4. Each member therefore has an incentive to cheat by producing above its quota or offering secret discounts.
5. If cheating is hard to detect, some members do cheat, other members see their sales fall and respond by cutting prices too.
6. The agreement collapses and the market returns towards the competitive, low-price outcome.
7. Where the game is repeated indefinitely, a strategy of matching whatever the rival did last time can make cheating unprofitable, which is why tacit collusion can last in stable markets with few firms.

The last step is the evaluation. The one-off prisoner's dilemma predicts that collusion fails; the repeated game shows when it can survive. Say which applies to the market in the question.

Define and frame: Define monopoly by market power and barriers to entry rather than by a share threshold, and define the consumer interest as covering price, output, quality, choice and innovation over time rather than price alone. Identify 'always' as the word under test, and state that the answer depends on economies of scale, on contestability and on what the profits are used for.

Analysis: the case against: Run the chain from downward-sloping AR through MR below AR to price above marginal cost at the profit-maximising output, supported by a monopoly diagram with the deadweight loss shaded. Add productive inefficiency, since output is not at minimum AC, and X-inefficiency, since protection from competition weakens the pressure to control costs. Note reduced choice and the transfer of consumer surplus into producer surplus.

Analysis: the case for: Take this seriously rather than conceding a token point. Economies of scale may put the monopolist's average cost so far below a competitive industry's that price is lower despite the mark-up, and this should be shown on a diagram. Supernormal profit funds research, which is the stated justification for patents. Natural monopoly makes competition wasteful. And price discrimination, while it harms some consumers, can extend access to others.

Evaluation: Weigh the conditions. Contestability may discipline a monopolist that faces no actual rival, so the structure may not predict the conduct. The dynamic case depends entirely on whether profits are reinvested or distributed, which is an empirical question and not guaranteed. Regulation can capture the scale economies while limiting the pricing abuse, which reframes the question from whether monopoly is bad to whether it is well governed. And the counterfactual matters: the alternative to a monopoly with scale economies is not the same industry with lower prices but a fragmented industry with higher costs.

Judgement: Reject 'always' and specify the conditions. Monopoly harms consumers where barriers are high, the market is not contestable, economies of scale are modest and profits are distributed rather than reinvested. It can benefit them where scale economies are large, entry is credible, or profits fund innovation consumers value. Note that the practical policy conclusion follows from this: regulate natural monopolies, keep markets contestable, and judge conduct rather than structure.