Why does there appear to be a movement towards oligopoly in certain markets? Evaluate how this affects the way in which producers make decisions, and how does it affect the welfare of consumers?

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Economics HL Essay

  1. Why does there appear to be a movement towards oligopoly in certain markets?
    [10 marks]
  2. Evaluate how this affects the way in which producers make decisions, and how does it affect the welfare of consumers?
    [15 marks]

Part A
In the market structure, oligopoly, there are a few firms which dominate an industry. The size of a firm with the relativity to the industry does not matter much, as in any case, with many or few firms, an oligopoly can exist when a small amount of firms share a great proportion of the output produced in the industry.
However, in a monopoly market structure, there is only one firm which dominates in an industry and it’s the only firm producing that certain product, therefore the firm is the industry. In this type of market structure, the monopolist (the dominating firm) has the ability to charge higher prices for the product and make abnormal profits. Also the firm does not have to produce at a productive efficiency nor allocative efficiency.

There can be different reasons for a movement towards oligopoly to appear in certain markets.
If there is a monopolist which operates in a perfectly contestable market for instance it could lead to an oligopolistic market structure. In a market where the costs of entry and exit by other rival firms is zero then a market is considered to be perfectly contestable.
Entry costs are barriers for a firm to enter the industry, these barriers could be that all the raw materials are owned by the monopolist (then nobody else could enter), but they could also be legal barriers such as that a firm must have the legal right to produce a certain product or a firm which has an intellectual property right such as a copyright on a certain product. Exit costs are costs that may be lost when exiting an industry because a firm could not get rid of its capital equipment such as machinery, these costs are referred to as sunk costs.
When neither of these costs exist in a monopoly, then monopolists have the threat of potential competition, potential competition occurs when a firm is selling at high prices and not producing efficiently and therefore it gives the possibility for other firms to be attracted to this certain industry and may enter. The monopolist will therefore charge reasonable prices as the threat of there actually being competition could serve the same as there being competition. If the monopolist doesn’t drop the price of its products though, there could be other firms entering the industry and therefore it could turn into an oligopolistic market structure.

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Part B

A market heading towards an oligopoly may have different effects on both the producers and the consumers. There are two types of oligopoly market structure; collusive and non-collusive. When a collusion exists in an oligopoly, there is either a formal or tacit agreement between two or more firms, these firms agree on a certain price they will all sell at and a quota of output each firm will produce/ sell. This will cause the firms not to have to compete with each other and have a fixed (high) revenue. Also there could be a collusion between firms which ...

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