AQA ECON3 JANUARY 2011 ESSAY 2
D Oligopolies are concentrated markets with a few firms sharing a large percentage of market supply, while a contestable market has low entry and exit barriers. Sunk costs (such as advertising or capital investments which cannot be recovered) and legal barriers creating statutory monopolies are examples of entry barriers which reduce contestability.
I Oligopolistic markets may not operate efficiently if firms enjoy price-making powers. An
This is especially likely if collusion occurs. Collusion offers firms the opportunity to limit the uncertainty generated by interdependence in oligopolistic markets. There is the potential for firms to operate as a joint monopoly, with the effect that output is squeezed and price is raised. As a result the price (which indicates the marginal benefit received by the last consumer) is raised above the marginal cost of production. This suggests that further units of the good could be produced and that these units would carry a net benefit to society.
Collusive oligopoly is then seen as a source of inefficiency, creating a market failure and a deadweight welfare loss to society. This is illustrated in the diagram.
An Diagram Collusive oligopoly may reduce efficiency

I Making oligopolistic markets more contestable has the potential to improve the efficiency of the market. An This is because removing entry barriers allows the threat of potential new competition to act as a discipline on the conduct of incumbent firms. Incumbents are less likely to collude if entry barriers are low, because collusion raises prices and creates supernormal profit, which acts as a signal for new firms to enter the market. Given that incumbents are unlikely to welcome new entry, this threat may cause them not to collude. I
Indeed, it points towards the possibility of incumbent firms adopting entry limit