What you'll learn
- Why governments worry about weak competition, monopolies and mergers.
- How competition authorities and regulators try to promote competition and contestability.
- Why more competition is often desirable — but not always.
- How to evaluate competition policy in Eduqas-style essays using efficiency, welfare and real-world context.
Starting point: why competition matters
In market structures, competition means firms face pressure from rivals when selling goods and services. If a firm raises price, cuts quality or becomes inefficient, consumers can switch to another supplier.
Competition policy
Competition policy is government action designed to prevent or reduce anti-competitive behaviour, protect consumers, and encourage markets to work more efficiently.
Competition policy matters because markets do not always self-correct. If one or a few firms gain strong control over a market, they may raise prices, restrict output, reduce choice or slow innovation.
The big purpose
Competition policy is mainly about improving consumer welfare — the overall benefit consumers receive from lower prices, better quality, more choice and innovation.
Market power and monopoly
Market power
Market power is the ability of a firm to influence the market price, usually by restricting output or differentiating its product from rivals.
A firm with significant market power may not behave like a competitive firm. In perfect competition, firms are price takers. But a firm with market power can be a price maker: it has some control over the price it charges.
Monopoly
A monopoly exists where one firm dominates the supply of a good or service. In UK competition analysis, a firm with 25% or more of a market may be treated as having monopoly power, although dominance depends on the context.
Governments may be concerned about monopolies because they can lead to:
- Higher prices than in a more competitive market.
- Lower output, meaning fewer consumers are served.
- Allocative inefficiency, where price is above marginal cost.
- Productive inefficiency, where firms fail to produce at the lowest possible average cost.
- X-inefficiency, where lack of competitive pressure allows wasteful management or overstaffing.
- Less choice for consumers.
- Anti-competitive behaviour, such as predatory pricing, exclusive contracts or refusal to supply rivals.
The monopoly diagram below shows the classic welfare concern: a monopolist restricts output to Qm and charges Pm, rather than producing at the more competitive outcome Qc and Pc.
Interpreting monopoly welfare loss
- The monopoly chooses output where marginal revenue equals marginal cost, so it produces Qm rather than Qc.
- It then charges the highest price consumers are willing to pay for Qm, shown by the demand curve at Pm.
- Compared with the competitive outcome, price is higher and output is lower, so some mutually beneficial trades no longer happen.
- The shaded triangle is the deadweight welfare loss: lost welfare that is not gained by either consumers or producers.
Assuming monopoly is always bad
A monopoly may still be efficient if it benefits from large economies of scale, invests heavily in research and development, or operates as a natural monopoly where one large supplier can produce at a lower average cost than several smaller firms.
Why governments worry about mergers
Merger
A merger occurs when two or more firms combine to form one larger business. A takeover is where one firm buys control of another.
Mergers may concern governments because they can reduce the number of competitors in a market. If two major supermarkets, banks, airlines or energy suppliers merge, the new firm may gain more market power.
A merger can be:
- Horizontal: between firms in the same industry, such as two mobile phone networks.
- Vertical: between firms at different stages of production, such as a manufacturer buying a supplier.
- Conglomerate: between firms in unrelated markets.
Horizontal mergers are often the biggest competition concern because they directly reduce rivalry.
Market concentration
Market concentration measures how much of a market is controlled by the largest firms. A highly concentrated market is dominated by a small number of firms.
Assessing a merger using market shares
Suppose a UK broadband market has five firms with market shares of 32%, 24%, 18%, 14% and 12%. The firms with 24% and 18% plan to merge.
- Before the merger, the four largest firms have a combined share of 32% + 24% + 18% + 14% = 88%, so the market is already highly concentrated.
- After the merger, the new firm would have 42% of the market, making it larger than the previous market leader.
- The merger may reduce competitive pressure because one major rival disappears and the merged firm may have greater ability to raise prices.
- However, the final judgement depends on whether cost savings, investment or stronger competition against the leader could benefit consumers.
But mergers can have benefits
Competition authorities do not automatically block every merger. A merger may improve efficiency if the combined firm can reduce duplicated costs, spread fixed costs over more output, or invest more in innovation.
Economies of scale
Economies of scale occur when average cost falls as output increases.
For example, a merged pharmaceutical firm may have more funds for research and development. A larger supermarket chain may negotiate lower supply costs, potentially passing some savings to consumers through lower prices.
The merger trade-off
The core question is whether the merger is likely to substantially reduce competition, or whether efficiency gains are strong enough to benefit consumers.
Contestability: competition without many firms
A market can be disciplined not only by current rivals, but also by the threat of entry.
Contestability
A contestable market is one where firms can enter and leave easily, so existing firms behave competitively because they fear potential rivals.
Contestability depends on:
- Low barriers to entry, such as low start-up costs or easy access to suppliers.
- Low barriers to exit, especially low sunk costs.
- Access to technology, infrastructure or platforms needed to compete.
- Consumer willingness to switch suppliers.
- Information availability, so consumers can compare prices and quality.
Sunk cost
A sunk cost is a cost that cannot be recovered if a firm leaves the market, such as specialised advertising or equipment with no resale value.
Judging contestability in a market
Imagine two firms dominate an online tutoring platform market, but new firms can rent cloud software, advertise cheaply on social media and students can switch platforms easily.
- Low set-up costs reduce barriers to entry, so new firms can challenge the incumbents.
- If exit costs are low, entrants face less risk because they can leave without losing large sunk costs.
- The existing firms may keep prices lower and quality higher to discourage entry.
- The market may therefore be more competitive than its two-firm structure first suggests.
Contestability is not the same as lots of firms
A market with only a few firms can still be fairly competitive if entry is easy. A market with many firms can still be weakly competitive if consumers cannot switch or information is poor.
The role of competition authorities
Competition authority
A competition authority is a public body that investigates markets and firms to prevent anti-competitive behaviour and protect consumers.
In the UK, the main competition authority is the Competition and Markets Authority, often shortened to the CMA. For cross-border cases, the European Commission may also matter, but you do not need detailed knowledge of UK or EU competition legislation for this Eduqas section.
Competition authorities may:
- Investigate mergers that could reduce competition.
- Investigate cartels, where firms secretly agree prices or output.
- Investigate abuse of market power, such as predatory pricing or exclusive dealing.
- Conduct market studies into industries where consumers appear to get poor outcomes.
- Require firms to change behaviour.
- Approve, block or attach conditions to mergers.
- Fine firms for anti-competitive conduct.
Cartel
A cartel is an agreement between firms to limit competition, usually by fixing prices, restricting output or dividing up markets.
Cartels are damaging because they can make an oligopoly behave more like a monopoly: higher prices, lower output and less pressure to improve.
The role of regulators
Regulator
A regulator is a public body that oversees a particular industry, especially where competition may be naturally limited or consumers need extra protection.
Examples in the UK include Ofgem for energy, Ofwat for water, Ofcom for communications and the Office of Rail and Road for rail. You do not need detailed knowledge of regulatory policies, but you should understand their broad purpose.
Regulators may try to:
- Limit excessive prices, especially in utilities.
- Set service quality standards.
- Encourage switching by making information clearer.
- Require access to essential infrastructure, such as networks or pipes.
- Protect vulnerable consumers.
- Promote investment and reliability.
This matters because some markets are not easy to make fully competitive. Water supply, rail infrastructure and electricity networks can involve huge fixed costs, so direct duplication may be wasteful.
Natural monopoly
A natural monopoly occurs where one firm can supply the whole market at a lower average cost than two or more competing firms, usually because fixed costs are very high.
Saying regulators simply force low prices
Very low regulated prices may please consumers in the short run, but they can reduce profit and discourage investment. Good evaluation considers the trade-off between affordability, service quality and long-run investment.
Is competition always desirable?
Usually, more competition improves outcomes. It can lead to lower prices, better quality, more choice and stronger incentives to innovate. It can also reduce inflationary pressure in concentrated sectors and improve UK productivity by forcing firms to cut waste.
However, competition is not automatically best in every case.
Arguments for competition and contestability
Competition can improve:
- Allocative efficiency: resources are closer to what consumers want.
- Productive efficiency: firms minimise costs to survive.
- Dynamic efficiency: firms innovate to stay ahead.
- Consumer sovereignty: consumers have more choice and power.
- Fairness: less exploitation of consumers through excessive prices.
Arguments against too much competition
Too much competition can sometimes create problems:
- Firms may be too small to achieve economies of scale.
- Profits may be too low to fund research and development.
- Duplication of infrastructure may waste resources.
- Firms may cut costs by reducing quality or worker conditions.
- In essential services, instability can harm consumers if suppliers collapse.
Evaluating competition in energy markets
Suppose a government wants more competition in domestic energy supply after a cost-of-living squeeze.
- More suppliers may increase price competition, encouraging lower tariffs and better customer service.
- Easier switching can make the market more contestable because firms fear losing customers.
- However, if wholesale gas prices rise sharply, as seen during recent global energy shocks, competition alone may not prevent high bills.
- The government may need regulation or targeted support for vulnerable households, so competition policy is useful but not sufficient on its own.
How to evaluate competition policy
Strong evaluation asks: compared with what? A policy may improve one market but fail in another.
Useful evaluation angles include:
- Short run versus long run: blocking a merger may preserve competition now, but reduce investment later.
- Market characteristics: competition is easier in retail than in natural monopoly infrastructure.
- Size of efficiency gains: a merger may be acceptable if cost savings are large and passed on to consumers.
- Consumer behaviour: competition only works well if consumers can compare and switch.
- Regulatory failure: authorities may lack information or intervene too slowly.
- Global competition: a large UK firm may need scale to compete internationally.
- Distributional effects: low-income consumers may benefit most from lower prices in essentials such as energy, broadband or food.
Competition policy cannot fix every market failure
Competition policy mainly addresses market power. It may not solve externalities, information gaps, inequality or macroeconomic shocks without other policies.
In the exam
- Define the key concept precisely, such as monopoly power, merger, contestability or regulator.
- Explain the chain of reasoning: market power may lead to higher prices, lower output and welfare loss.
- Apply to a real market, such as UK energy, supermarkets, broadband, rail or digital platforms.
- Evaluate both sides: competition can improve efficiency, but economies of scale, investment and natural monopoly may justify some market power.
- Make a final judgement based on the market: ask whether consumers are genuinely protected in the long run.
Check yourself
- Why might a government investigate a merger between two large firms in the same market?
- How can a market be contestable even if it has only a few firms?
- Why might a regulator allow a firm to make profit rather than forcing prices as low as possible?
