AQA January 2010 Unit 3- Business Economics and Distribution of income

 AQA January 2010 Unit 3: Question paper

                                              Mark Scheme

Context 2

2 (a) Using Extract D, identify two main features of the market for motor vehicles in the EU. (5 marks)

Volkswagen has the greatest market share compared to other companies in the data. It has 18.3% of the market share which is 5.1% greater than the second largest company (Peugeot-Citroen)  in terms of market share with a respective 13.2% concentration ratio.

German companies have the largest market share compares to other countries. German companies accumulate to 28.8% of total market share. It has 6.2% greater market share than France. France has the second largest market share.

(b) Explain the concept of ‘minimum efficient scale’ (Extract E, line 30) and analyse its implications for the structure of, and barriers to entry to, the motor manufacturing industry. (10 marks)

Minimum efficiency scale (MES) is the lowest point on the average cost curve of a firm. At this point the production cost per unit is the smallest.

 As the data shows the motor manufacturing industry is dominated by EU competitors. This could be because the EU competitors such as Volkswagen and Peugeot Citroen have larger economies of scale compared to its other competitors such as the USA. if they have larger economies of scale they can produce goods at a smaller cost per unit. These low production costs are transferred to the customer via lower prices for cars. This is a direct relationship and it can form an entry barrier in the form of limit pricing. Other firms may not be able to compete with the lower prices thus forcing them to lose market concentration. In the long run they may be forced out the market resulting in a change in the dynamics of market structure, oligopolists arise and these oligopolists may develop monopolistic tendencies.



(c) ‘When oligopolists collude, the results can be anti-competitive and against the consumer interest’ (Extract E, lines 27–28). Evaluate policies that could be used to deal with this problem. (25 marks)

Oligopolist occur when there are a handful of firms in an industry that have majority concentration ratios. It is perhaps the most realistic form of market structure when compared to perfect competition and monopolist. This allows us to use real life examples to see how oligopolists behave. Take the energy industry, it is dominated by the 'big six' firms which together hold 92.4% of market share. They have been under much scrutiny for anti competitive practises which may be 'against the consumer interest' as extract E states. There are a number of ways governments can alleviate this problem

Neoclassical economists would argue that oligopolies form as a result of high entry barriers. Joseph Bain in 1956 identified cost advantage, capital requirement and product differentiation as entry barriers. The theory of contestable markets argues that these entry barriers are a cause of the lack of competition in the market. If governments were to remove these entry barriers then it would make more contestable and competitive. new firms may enter the market and set a price level lower than the artificially high prices of the oligopolies. This will cause oligopolies to lose market share and incentivise them to reduce their prices. This price level will have to be set at the price level that the new firms are willing to charge if the oligopolist is to retain its previous market concentration. Due to the constant threat of competition this price level is likely to be the oligopolists long term price position-preventing anti competitive practises and protecting consumer interest.

The major criticism of this approach is that in reality the governments will not be able to remove barriers to entry i.e if government wishes to remove capital requirement as an entry barrier it will have to increase the level of subsidies to all the new firms wishing to enter the market. This is simply not a viable option especially with the government debt at 80.2% of GDP (as announced in the 2015 budget). A more nuanced approach could be to reduce the entry barrier rather than to remove it completely i.e reduce the contract length of patents which are typically 20 years long but this is a rather short term solution to a long term problem.

Another policy which could be to set up regulatory bodies which would prevent collusion between oligopolies. In the past the government has set up independent regulatory bodies such as OFGEM and OFCOM which regulate the energy and communications sector respectively. Notably OFGEM has had success in reducing the power of oligopolies in markers. The concentration ratio of the 'big six' has decreased from 99.8% to 92.4% in 2014. As their concentration ratio decreases it allows for smaller, more competitive firms to enter the market. These smaller firms focus on price competitions rather than oligopolies which tend to accentuate non-price competition such as branding and advertisement. Lower prices lead directly on to increases in consumer sovereignty and consumer surplus.

Some people are quite sceptical about regulatory bodies. They argue that these independent bodies may become 'captured'. The theory of regulatory capture was theorised by George Stigler and shows how regulating bodies may become 'absorbed' by large firms to increase their super normal profits. An example would be the rating company Fitch and Moody, they gave banks higher credit and bond ratings than they should have because they feared losing clients and profits. Corollary, post recession the Dodd-Frank legislation was initiated by President Obama to plug the gaps in the regulations which the recession highlighted. Granted that Fitch and Moody is a private firm, there is still a possibility of a government created independent body being 'captured'.

Further policies include nationalising the oligopolies to make sure the government can control the price of goods. However, the vast administration costs would make this option not viable. In addition, nationalising shifts ownership from private to public sector. Free market economists would argue that this will increase inefficiencies because publicly owned firms have no incentive to reduce costs. Thus it can be said that there are benefits and drawbacks to each policy. Perhaps employing all the approaches to a lesser degree and spreading the inefficiencies would be the best outcome as indicated by the theory of second best.