One example of an oligopoly was recently discussed on this blog –supermarkets. Here, is another classic example: the energy sector. It is dominated by six big firms, which hold the majority of the market in an industry with high barriers to entry; there is inter-dependence between the firms; and there are accusations of price fixing and collusion – all typical features of an oligopoly that may operate against consumers’ interests.
There have been numerous investigations into the actions of these energy providers, owing to their high prices, a lack of competition and significant profits. Developments in the industry have focused on reducing the barriers to entry created by the vertical integration of the incumbent firms in order to make it easier for new firms to enter, thus boosting competition.
However, the latest step is the biggest one, with the energy regulator, Ofgem, referring this industry to the Competition and Markets Authority (CMA). The investigation is likely to last 18 months and will ‘leave no stone unturned in establishing the truth behind energy prices’.
One of the key things that will be investigated is the accusation of profiteering and thus whether the big six should be broken up. This would inevitably lead to reductions in entry barriers and more opportunities for new firms to enter the market, thereby creating a much needed increase in competition. The Chief Executive of Ofgem, Dermot Nolan said:
Now is the right time to refer the energy market to the CMA for the benefit of consumers…There is near-unanimous support for a referral and the CMA investigation offers an important opportunity to clear the air. This will help rebuild consumer trust and confidence in the energy market as well as provide the certainty investors have called for.
Further comments were made about the energy sector and the future direction in terms of market reforms. This was another reason given for the referral to the CMA. Dermot Nolan added:
A CMA investigation should ensure there are no barriers to stop effective competition bearing down on prices and delivering the benefits of these changes to consumers.
The impact of this latest news will undoubtedly be felt by the big six, with share prices already taking a small hit, as investors start to look ahead to the potential outcome, despite any decision not being expected for a good 18 months. The following articles consider this latest energy market development.
Ofgem puts big six energy suppliers under CMA spotlight The Guardian, Terry Macalister (26/6/14)
Ofgem refers ‘big six’ energy groups for competition probe Financial Times, Claer Barrett (26/6/14)
U.K. energy regulator Ofgem asks for utilities probe Wall Street Journal, Selina Williams (26/6/14)
Energy probe could lead to ‘major structural change’ BBC News (26/6/14)
Probe into energy firms’ £100 per home profits The Telegraph, Emily Gosden (26/6/14)
UK competition watchdog kicks off energy suppliers probe Reuters (26/6/14)
Energy sharks may £101 profit per family: Major inquiry launched into power Mail Online, Sean Poulter (26/6/14)
Big six energy firms face full competition probe Independent, Simon Read (26/6/14)
Questions
- How well does the energy sector fit the structure of an oligopoly?
- What are the barriers to entry in the energy market? How can this referral to the CMA help to reduce them?
- Which factors determine the price of energy?
- The big six have been accused of profiteering. What is meant by this and why is it against the public interest?
- Why has it taken so long for such a referral to take place?
- In the BBC News article, the suggestion is that this investigation could lead to a ‘major structural change’. What is meant by this and why is it a possibility?
Oligopoly is the most complex market structure, characterised by a few large firms which dominate the industry. Typically there are high barriers to entry and prices can be very sticky. However, perhaps the most important characteristic is interdependence. With this feature of the market, oligopolies, despite being dominated by a few big firms, can be the most competitive market structure.
There are many examples of oligopolies and one of the best is the supermarket industry. Dominated by the likes of Tesco, Morrisons and Asda, competition in terms of branding, product development and quality is constant, but so is price competition. 
During the recession, you could hardly watch a TV programme that included advert breaks without seeing one of the big four advertising their low prices.
However, in the past few years, the supermarket industry has seen competition grow even further and the big four are now facing competition from low-cost retailers, including Aldi and Lidl. This has led to falling sales and profits for the likes of Tesco and Morrisons.
Tesco, Morrisons, Sainsbury’s and Asda have all felt the emergence of discount retailers and have seen their customer numbers fall. All have reacted with rounds of price cuts and new deals, and this price war looks set to continue. Morrisons have just announced a 14% average price cut on 135 products to match earlier changes in pricing strategies by the other main competitors. As I’m writing this during the Algeria v. South Korea match, I have just seen an advert from Sainsbury’s, promoting their milk chocolate digestive biscuits, priced at £1. The advert explicitly states that they are ‘less than Morrisons’, where the price is £1.50. This was soon followed by another from Sainsbury’s saying that 
the Cif bathroom spray is £1.50, which is ‘less than Tesco’, priced at £2.75. I need say no more.
So, what is it about this industry which means it is so susceptible to price wars? Are all oligopolies like this? The following articles consider the supermarket industry and the price wars that have emerged. Think about this sector in terms of oligopoly power and consider the questions that follow.
Morrisons announces another round of price cuts/a> BBC News (22/6/14)
Tesco suffers worst sales for decades The Guardian, Sarah Butler and Sean Farrell (4/6/14)
Britain’s Morrisons to cut prices on 135 products Reuters (22/6/14)
Morrisons slashes more prices by up to 41pct The Telegraph, Scott Campbell (22/6/14)
Sainsbury’s and Netto in discount store tie-up BBC News (20/6/14)
Slow to respond, Tesco now pays the price Wall Street Journal, Peter Evans and Ese Erheriene (19/6/14)
One million fewer customer visits a week at Tesco The Guardian, Sean Farrell (3/6/14)
Asda only one of big four to grow share as Lidl achieves highest ever growth Retail Week, Nicola Harrison (3/6/14)
Will Asda shoot itself in the foot with in-store cost cutting? The Grocer, Alec Mattinson (28/5/14)
Tesco sales slide at record speed as discounters pile on the pressure Independent, Simon Neville (3/6/14)
Quester: Back J Sainsbury to prove doubters wrong The Telegraph, Graham Ruddick (11/6/14)
Questions
- What are the key characteristics of an oligopoly?
- How do the above characteristics explain the conduct of firms in an oligopoly? How relevant is this to the supermarket industry?
- In many oligopolies, prices are sticky. Why is it that in the supermarket industry price wars break out?
- Is the kinked demand curve a relevant model to use when talking about the supermarket industry?
- What other industries fit into the category of an oligopoly? Is the kinked demand curve model relevant in these industries?
- Would there be an incentive for the big 4 supermarkets to collude and fix price? Explain your answer.
- Interdependence is the key characteristic in an oligopoly. Can this explain the behaviour of the supermarkets?
- Given that oligopolies are characterised by high barriers to entry, how is that Aldi and Lidl have been able to compete with them?
What does it take to create a successful business? From the looks of it: mud, electric barbed wire, icy water, enormous walls to climb, big jumps to make, team work and complete exhaustion – the recipe for every successful business.
Tough Mudder was founded in 2010 and runs gruelling extreme obstacle courses for anyone mad enough to think it might be fun. In the BBC News article below, you’ll see that there is a discussion as to intellectual property rights, but whatever the outcome, this company has become the main provider of such extreme sports in a remarkably short period of time. Within 2 years of being established, it had gained 500,000 participants and now records annual revenues of more than £60m. Add to this, that there has no external funding and this organic growth is beyond impressive.
A key question, then, is what creates such a successful business? Without a doubt, this depends on the product you are selling and the market a firm is in, but there are some aspects that apply across the board. Understanding what your customers want is crucial, as they represent your demand. Differentiating your product to create inelastic demand may be a good strategy to enable price rises, without losing a large number of sales, but the differentiated product is essential in establishing demand, loyalty and reputation. Marketing something in the right way and to the right audience is crucial – word-of-mouth is often the most effective form of advertising.
If you have all of these aspects, then you have the makings of a successful business. The next step is putting it into practice and climbing those high walls, taking the big jumps and hopefully avoiding the mud and ice. The following article considers Will Dean and his fast growing business.
Will Dean: ‘The Mark Zuckerberg of extreme sports’ BBC News, Will Smale (9/6/14)
Questions
- If you were starting up a business, how might you go about finding out if there is a demand for your product?
- Why is product differentiation a key aspect of a successful business? Using a diagram, explain how this might help a firm increase revenue and profits.
- What forms of marketing might be used in persuading customers to buy your product?
- In the case of Tough Mudder, which aspects have proved the most important in creating such a successful business?
- Are there any barriers to the entry of new firms in this sector? If so, what are they are how important are they in allowing Tough Mudder to retain a monopoly position?
- Which factors should be considered by a company when it is thinking of global expansion?
The most commonly used measure of economic performance is GDP and while there is agreement that it is an important and useful measure, there is also agreement that there are some big problems with it. Does it measure welfare or quality of life? What is and isn’t included? Do some things add to GDP which actually make us worse off?
One criticism often levelled at GDP is that there are many aspects that go unmeasured – often known as the underground economy. Some areas are typical everyday things – DIY, looking after your own children rather than paying someone to do it, or even giving yourself a haircut. But, there are other activities, often illegal, which go unrecorded, such as the selling and distribution of drugs and prostitution. In countries like the Netherlands, their GDP figures get a boost, as some drugs and prostitution are legal. In other countries, such data is not recorded and as such, the contribution of these markets is under-estimated or even completely omitted.
However, this aspect of the calculation of GDP statistics is changing across Europe, which will allow much easier and more meaningful comparisons of relative GDP across countries. This extra production will therefore offer a positive contribution towards our GDP and perhaps suggest to the untrained eye that the British economy is growing, which can only be good news. But, for the trained economist, we are looking at extra data being added, which will boost total output and the question will be does it really indicate that the economy is better off? The following articles consider this change to GDP.
Small data: The way drugs and prostitution boost the economy BBC News (4/4/14)
Small data: Calculating the sex and drugs economy BBC News (2/6/14)
UK economic output to be revised up after ONS updates BBC News, Anthony Reuben (10/6/14)
UK economic output will get near 5 percent boost from data changes Reuters (10/6/14)
Accounting for drugs and prostitution to help push UK economy up by £65bn The Guardian, Katie Allen (10/6/14)
Questions
- What does GDP measure? Is it good at measuring it?
- Explain the pros and cons of using GDP to measure the welfare of an economy.
- Why are there problems using GDP to compare output between countries?
- Is it a good idea to include markets such as sex and drugs in calculating a nation’s output?
- What other measures of welfare do we have?
At the end of January 2014, we looked at the problem of deflation and in particular at the fortunes of Japan, as its CPI was rising. As the blog explained, the Japanese economy, rather than being plagued by high inflation has been plagued by deflation and many suggest this is even worse.
In December 2013, Japan’s core consumer prices were growing faster than expected. The data gave the economy a much needed boost, following increases in government spending aimed at stimulating aggregate demand. This in turn pushed up prices, such that they achieved their fastest rate of growth in 5 years. Now, more recent date from May 2014 shows that the trend has continued. Prices in Japan have now increase at their fastest rate in 23 years, rising 3.2% and beating the forecasts of 3.1%. This means that prices have no risen in Japan for 11 consecutive months. Numerous policies have contributed towards this impressive trend for an economy plagued by deflation for 2 decades. Boosts in the money supply, increases in government spending, a rise in sales tax are just some of the contributing factors.
Although the economy is certainly over the problem of deflation, some are now concerned that such price rises may reduce consumer spending. An ironic twist, given that barely a year ago the concern about low consumer spending was due to deflation. The next 12 months will be a key indicator of how consumers will respond to this unusual inflation data – after all inflation and high prices have been pretty uncommon. The following articles consider the update on the Japanese economy.
Japan inflation rate hits 23 year high (including video) BBC News (30/5/14)
Japan April core CPI rises to 23-year high after sales tax rise Reuters (29/5/14)
Japan inflation accelerates Wall Street Journal, Takashi Nakamichi (30/5/14)
Japan’s consumer inflation set to reach five year high The Guardian (18/4/14)
Japan’s inflation at highest rate for 23 years The Telegraph, Rebecca Clancy (30/5/14)
Japan inflation quickens to fastest since 1991 Bloomberg, Toru Fujioka (30/5/14)
Japaense inflation rises at fastest pace in over five years at 1.3% in December 2013 Independent, Russel Lynch (31/1/14)
Questions
- Why is deflation a problem?
- Using an AD/AS diagram, illustrate the problem of expectations and how this contributes to stagnant growth.
- Japanese policies have helped create a rise in the CPI. Which policies have been effective in creating rising prices?
- Explain how the sales tax has contributed towards higher prices.
- With prices rising, there are now concerned that consumer spending may decline. Using a diagram, explain why this may be the case.
- In the previous blog, we analysed the Indian economy and said that high inflation was something that was contributing towards lower growth. How is that low inflation or deflation can also contribute towards low growth?
One example of an oligopoly was recently discussed on this blog –supermarkets. Here, is another classic example: the energy sector. It is dominated by six big firms, which hold the majority of the market in an industry with high barriers to entry; there is inter-dependence between the firms; and there are accusations of price fixing and collusion – all typical features of an oligopoly that may operate against consumers’ interests.
