Oligopoly - Questions & Answers

Question 1

There is clear evidence that the UK supermarket sector, as with the supermarket sectors in many economies, is increasingly dominated by a few firms.

1. Using example, indicate how supermarkets compete with each other? (6)
2. Explain why the supermarket sector is increasingly dominated by a few large firms. (6)
3. What are the likely effects of this domination on:

Prices (2)

Profits (2)

Efficiency (2)

Economic welfare (2)

Question 2

What could the regulators do to limit the power of supermarkets.

Question 3

Assess price and non-price strategies used by major airlines.

See answer

Question 4 – Extended data response

The UK banking sector

Extract 1 – market shares

The UK banking sector is dominated by a few very large banks, including Barclays, the Royal Bank of Scotland (RBS), and HBOS. In term of market shares, just a few firms dominate. Despite the popularity of online banking, and the possibility of new banks entering the market, smaller banks represent a modest proportion of the total market supply of personal financial services.

Banks market shares

In response to the credit crunch, the UK banking sector has accelerated the process of integration. In January 2009 the Halifax Bank of Scotland (HBOS) merged with Lloyds TBS to create the Lloyds Group. In 2002 the Competition Commission concluded that a number of the largest banks operated a complex monopoly in the supply of services to small and medium sized enterprises (SMEs) which resulted in reduced competition to the detriment of the customers. For example, customers were reluctant to switch banks because they all offered very similar benefits. Following the financial crisis the banking industry increased its level of concentration. The banking H-H Index rose from 1401 in 2007 to 1736 in 2010, where an index score of 2000 is regarded as highly concentrated.

Extract 2 – the failure of self regulation

One notable consequence of the recent global financial crisis was the recognition that existing regulation of financial institutions has failed. Self-regulation via banking codes failed to prevent the 2008/09 banking crisis, as did national regulation.

Up until to 2013, banking regulation in the UK involved three organisations, the Financial Services Authority (FSA) the Bank of England and the Treasury. Until the banking crisis, UK banking regulation could be described as light-touch – in other words, regulators do not engage in aggressive regulation, preferring to intervene only when necessary, and only in limited ways.

Extract 3 – Rules vs Principles

With rule-based regulation the regulators interpret the rules as laid down in law, and there is little room left for judgement or interpretation. Under a principles-based system the general principles are contained in legislation, and this gives regulators extra powers to assess the behaviour of financial institutions.

Extract 4 – The new (post 2013) regulatory framework

In the UK a new regulatory structure governing financial service provision came into effect in April 2013. Following the Financial Services Act (2012), the Financial Services Authority (FSA) ceased to exist, and two new regulatory authorities, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) were put in its place.

The Prudential Regulation Authority (PRA)

The main objective of the PRA, which is part of the Bank of England, is to create a stable financial system for the UK. To help ensure stability, the PRA was given responsibility for the prudential regulation of around 1700 financial institutions, including banks, building societies and credit unions.

The Financial Conduct Authority (FCA)

The independent FCA was given responsibility for ensuring that financial markets work effectively and that the conduct of firms in financial markets and meets the standards laid down in legislation. The FCA is, effectively, the watchdog that ensures competition is maintained, and that banks do not abuse their dominant positions.

Extract 5 – Anti-competitive behaviour exposed

Barclays Bank has been fined £26m by UK regulators after one of its traders was discovered attempting to fix the price of gold. The trader, who has been sacked, exploited weaknesses in the system to profit at a customer’s expense, the Financial Conduct Authority (FCA) said.

The incident occurred in June 2012, the day after the bank was fined a record £290m for attempting to rig Libor. Barclays said it “very much regrets the situation” that led to the fine. The FCA found the bank failed to “adequately manage conflicts of interest between itself and its customers”, in relation to fixing the price of gold.

(Source: BBC News)

In a separate development, the European Commission has accused JPMorgan, HSBC and Credit Agricole of colluding to fix a key euro benchmark borrowing rate – Euribor. JP Morgan and HSBC will fight the charges. Credit Agricole will study the European Commission’s findings. Penalties for the guilty are up to 10% of annual revenue. Euribor is a cousin to Libor, which is used to set trillions of dollars of financial contracts from complex financial transactions to car loans.

In December, the Commission imposed fines totalling 1.04bn euros on Deutsche Bank, RBS and Societe Generale as part of the same investigation. Barclays escaped a fine as it had notified the Commission of the existence of the cartel, and the others were granted a 10% reduction in their fine for agreeing to a settlement.

The EU’s competition body said: “The Commission has concerns that the three banks may have taken part in a collusive scheme which aimed at distorting the normal course of pricing components for euro interest rate derivatives.”

JP Morgan said it had “co-operated fully with the European Commission throughout its investigation.” The bank said it believed that the competition concerns were “without merit”, and added it intended to “defend itself fully”.

(Source: BBC News)

Questions

a)     What type of market structure best describes the UK banking sector? (4)

b)     Identify two alternative and competing business objectives of UK banks. (6)

c)     What type of integration best describes mergers between banks? (4)

d)     With reference to Figure 1 and Extract 1, explain how the level of concentration in the banking industry changed between 2007 and 2010. (8)

e)     What is meant by the phrase ‘complex monopoly’? (4)

f)     Assess alternative ways that banks could increase their profitability in the future – use a diagram to support your answer. (14)

g)     Using a diagram, assess the likely level of bank’s efficiency prior to tighter regulation from 2013 onwards. (14)

h)     Outline two different ways banks could ‘exploit their dominant position’. (6)

i)      With reference to the data, and your own knowledge, assess the level of contestability in the personal banking sector. (8)

j)      Assess the likely effects of a merger between two large banks. (12)

k)     Using Game Theory, explain why there might be an underlying tendency for UK banks to undertake tacit or even covert collusion. (14)

l)      Assess alternative strategies that the FCA could adopt to ensure that there is effective competition between UK financial institutions. (16)

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