HookThe £7 billion merger the CMA refused to allow

In April 2019 the Competition and Markets Authority killed the biggest UK retail deal in a generation: Sainsbury's roughly £7.3 billion plan to buy Asda. The combined group would have controlled close to 30% of British grocery spending — bigger than Tesco — and the CMA concluded shoppers would face higher prices and worse choice in hundreds of local areas. The two chains argued the opposite: only scale, they said, could hold prices down against the discounters.

The discounters settled the argument. By September 2022 Aldi had overtaken Morrisons to become Britain's fourth-largest supermarket, and Tesco was pegging hundreds of products to Aldi's prices through its Aldi Price Match scheme, launched in 2020. No regulator ordered that — the threat of losing customers did. Everything in this section lives inside that story: how the structure of a market (how many firms, how big, how hard to enter) shapes conduct (pricing, collusion, innovation) and performance (who captures the surplus). Structure, conduct, performance — and always, underneath, the question of entry.

ModelThe spectrum of market structures — and how to measure concentration

Economists classify markets by four features: the number and relative size of firms, barriers to entry and exit, the degree of product differentiation, and the quality of information. At one end sits perfect competition (many tiny firms, identical products, free entry); at the other, pure monopoly (one seller, blocked entry). Almost every real market lives in between, in monopolistic competition or oligopoly.

The standard measuring stick is the n-firm concentration ratio: the combined market share of the n largest firms. UK groceries is the classic oligopoly — a CR4 around two-thirds — while markets like hairdressing have CR4s in single figures. AQA rewards students who treat the ratio as a starting point, not a verdict: it says nothing about the threat of entry, and it can fall (as in groceries since 2010) even while the biggest firm stays dominant.

Worked example

Using Kantar-style grocery shares from 2024 — Tesco roughly 27.6%, Sainsbury's 15.3%, Asda 12.6%, Aldi 10.0% — the four-firm concentration ratio is 27.6 + 15.3 + 12.6 + 10.0 = 65.5%. A decade earlier the same calculation on the then Big Four (Tesco, Asda, Sainsbury's, Morrisons) gave a CR4 nearer 75%. Same market, falling concentration — hard evidence of the discounters' disruptive entry, and a ready-made application point for a data question.

ModelWhat firms actually maximise

The textbook firm maximises profit at the output where marginal cost equals marginal revenue: produce a unit if it adds more to revenue than to cost, stop when it does not. But the AQA spec explicitly wants the alternatives. Revenue maximisation (output where MR = 0) suits managers whose pay and prestige track sales. Growth and sales-volume maximisation build empires and deter entry. Satisficing — Herbert Simon's term — means earning just enough profit to keep shareholders quiet while pursuing other goals, from a quiet life to environmental targets.

The deep reason objectives diverge is the divorce of ownership from control: shareholders own public companies, salaried managers run them, and the two groups want different things — the principal–agent problem. Amazon is the modern case study: it reported near-zero profit for the best part of two decades while pouring revenue into growth, and shareholders tolerated it because the objective was market dominance first, profit later. Objectives matter in essays because the predictions change: a revenue-maximising monopolist produces more, and charges less, than a profit-maximising one, so the welfare verdict on the same market structure shifts with the objective you assume.

ModelPerfect competition and monopolistic competition — the benchmark and the high street

Perfect competition's assumptions — many buyers and sellers, homogeneous products, perfect information, no barriers to entry or exit — make every firm a price taker facing perfectly elastic demand. If supernormal profit appears in the short run, entry shifts market supply right and competes it away; long-run equilibrium leaves only normal profit, with price equal to marginal cost (allocative efficiency) and output at minimum average cost (productive efficiency). Nothing real quite qualifies — currency markets and some agricultural markets come closest — but that is not the point. It is the benchmark against which every real structure is judged.

Monopolistic competition is the British high street: many sellers, low entry barriers, but differentiated products — takeaways, hairdressers, nail bars, cafés. Differentiation buys each firm a gently downward-sloping demand curve and short-run supernormal profit; easy entry erodes it to normal profit in the long run. The cost: price sits above marginal cost and firms carry excess capacity. Mild inefficiency is the price consumers pay for variety — a line worth writing in exactly those words.

MechanismOligopoly — the economics of watching your rivals

Oligopoly is defined less by counting firms than by interdependence: each firm's best move depends on what rivals do, which is why game theory earns marks here. The prisoner's dilemma explains the two poles of oligopoly behaviour. Compete — price wars like the supermarkets' 2014–16 round, which shrank industry revenue while barely moving market shares — or collude, overtly or tacitly, and behave like a shared monopoly.

Overt collusion is illegal: in 2011 the OFT fined supermarkets and dairy processors just under £50m for coordinating milk and cheese prices back in 2002–03. Tacit collusion — price leadership, focal points, 'following' a rival's announced rise — is harder to prosecute and probably more common. The kinked demand curve model predicts price rigidity: rivals match your price cut (so demand is inelastic downwards) but ignore your rise (elastic upwards), so prices stick even when costs move. Treat it as one model among several, and say so — examiners reward candidates who know it cannot explain how the price reached the kink in the first place.

ModelMonopoly power and price discrimination

Pure monopoly means a single seller, but UK competition policy works with monopoly power: a 25% market share is the working threshold. Power comes from barriers — economies of scale (at the extreme, natural monopoly: one national grid is cheaper than two), patents, branding, control of key inputs. A profit-maximising monopolist restricts output below the competitive level and prices above marginal cost, converting consumer surplus into producer surplus and destroying some outright — the deadweight welfare loss triangle AQA expects you to shade and label.

Price discrimination — charging different prices for the same product where costs do not differ — needs three conditions: price-setting power, separable groups with different price elasticities of demand, and no resale between them. Peak and off-peak rail fares, the 16–25 Railcard and airline dynamic pricing all qualify. It is not automatically bad: the extra revenue can keep loss-making off-peak services running, and the elastic group often pays less than a single price would have charged them.

Worked example

A train operator charges everyone £35 and carries 800 commuters plus 400 leisure travellers: revenue = 1,200 × £35 = £42,000. It switches to £50 peak and £20 off-peak. Commuters barely respond — 700 still travel (a 12.5% quantity fall against a 43% price rise: inelastic). Leisure demand jumps to 900 (a 125% rise against a 43% price cut: elastic). New revenue: 700 × £50 + 900 × £20 = £35,000 + £18,000 = £53,000 — £11,000 more from the same trains. Third-degree price discrimination doing exactly what the theory says: charge the inelastic group more and the elastic group less.

MechanismCompetition as a process — dynamics and contestability

The spec treats competition as a process, not a state — Joseph Schumpeter's 'creative destruction': supernormal profit is a flare that attracts entrants, who imitate, undercut and innovate until either the profit is gone or the incumbent is. Aldi and Lidl are Britain's best recent example: a combined share of roughly 5–6% in 2010 grew to around 18% by the mid-2020s, and the Big Four's response — price matching, range cuts, own-label expansion — was the competitive market process working in plain sight.

William Baumol's theory of contestable markets (1982) pushes further: what disciplines incumbents is not the number of actual rivals but the threat of entry. If entry and exit are costless — crucially, if there are no sunk costs — even a monopolist must price near cost or invite 'hit-and-run' entry that grabs the profit and leaves. That insight shifted policy away from breaking firms up and towards lowering entry barriers. Evaluate with care: digital markets cut some sunk costs (a challenger bank like Monzo needs no branch network) but network effects and data advantages build new barriers at least as high.

ModelEfficiency, surplus — and the exam's favourite trade-off

Static efficiency has two parts: allocative (price equals marginal cost, so resources follow consumer preferences) and productive (output at minimum average cost). Perfect competition delivers both in long-run equilibrium; monopoly typically delivers neither, and a protected monopolist may drift into X-inefficiency — costs padded above the achievable minimum because no competitive pressure forces discipline. Dynamic efficiency is improvement over time: new products and processes funded by retained supernormal profit. AstraZeneca spent around $11bn on R&D in 2023 — spending only a firm with market power and patent protection could sustain.

Consumer surplus is willingness to pay minus price; producer surplus is price minus willingness to sell. Market structure decides who pockets them: competition pushes surplus towards consumers, monopoly pulls it towards producers and burns some as deadweight loss. The 25-mark tension follows: perfect competition wins on static efficiency, but concentrated markets may win on dynamic efficiency — Schumpeter's defence of monopoly. A judgement that weighs the two against a stated criterion (contestability, time horizon) is what a Level 5 answer looks like.

VocabularyKey terms the mark scheme pays for

Concentration ratio

The combined market share of the n largest firms (e.g. CR4). High ratios signal oligopoly, but say nothing about the threat of entry.

Profit maximisation (MC = MR)

Producing every unit that adds more to revenue than to cost, stopping where marginal cost equals marginal revenue — the default objective assumed in diagrams.

Satisficing

Earning enough profit to keep shareholders content while pursuing other objectives — a consequence of the divorce of ownership from control.

Supernormal profit

Profit above normal profit (the minimum needed to keep resources in their current use). In competitive markets it is the signal that attracts entry.

Interdependence

The defining feature of oligopoly: each firm's best pricing and output decision depends on how rivals are expected to react.

Natural monopoly

A market where one firm can supply total demand at lower average cost than two or more could, because fixed costs dominate — water pipes, the grid.

Third-degree price discrimination

Charging separable consumer groups different prices for the same product based on their different price elasticities, with no resale possible.

Contestable market

A market with costless entry and exit, so the threat of hit-and-run entry forces incumbents to price competitively regardless of how few firms exist.

Sunk costs

Costs that cannot be recovered on exit (advertising, specialised kit). The lower they are, the more contestable the market.

X-inefficiency

Operating above the lowest achievable average cost because weak competitive pressure lets organisational slack persist.

Consumer surplus

The gap between what consumers are willing to pay and what they actually pay — the area under the demand curve above the price.

Dynamic efficiency

Falling costs and better products over time, driven by investment and innovation typically funded from retained supernormal profit.

TrapsMisconceptions that cost marks

“A monopoly means there is only one firm in the market.”

Actually: That is pure monopoly, which is rare. UK competition policy uses a working threshold of 25% market share for monopoly power — Tesco is treated as having significant market power with under a third of the grocery market. Power is a spectrum, not a headcount.

“Oligopoly always means high prices for consumers.”

Actually: Interdependence cuts both ways. The same structure that enables tacit collusion also produces price wars — the UK supermarkets spent 2014–16 destroying their own industry revenue, and Tesco now voluntarily pegs prices to Aldi's. Behaviour depends on the payoff matrix, not the label.

“Contestability is about how many firms are currently in the market.”

Actually: It is about the threat of entry, which turns on sunk costs. A market with one incumbent and zero sunk costs can behave more competitively than a five-firm market ringed by high entry barriers — that is Baumol's whole point.

ExamWhat examiners want

This section carries more Paper 1 weight than almost any other. Diagrams are non-negotiable: for perfect competition, draw industry and firm side by side and show the short-run-to-long-run adjustment as entry shifts supply; for monopoly, shade the deadweight loss triangle and label the transfer of consumer surplus to the producer. AQA mark schemes credit diagrams that are used — meaning your written analysis explicitly references the areas and points you drew.

On the 9-mark data question, two developed chains of reasoning beat four assertions, and each chain should quote a number from the extract — a market share, a profit figure, a price change. On 25-markers, the top levels demand a supported judgement: strong candidates pick a criterion — contestability, the firm's objective, static versus dynamic efficiency, the time horizon — and rule with it. 'Monopoly is bad because prices are higher' is Level 2; 'this monopoly faces low sunk costs and funds R&D a fragmented market could not, so intervention risks dynamic efficiency for a static gain' is Level 5 territory.

Two traps to avoid. First, never treat a concentration ratio as conclusive — the CMA blocked Sainsbury's–Asda on local-area competition analysis, not the national CR4, and a contestable market can be concentrated yet behave competitively. Second, when a question raises price discrimination, test the three conditions against the actual context before evaluating — application marks come from checking market power, separability and resale in the case given, not from reciting the definitions.

Competitive & concentrated markets.