Section A of the 2022 AQA A level economics paper 1 was all about market concentration in the supermarket sector. The 25 mark question asked the extent to which this was serving customer interests well. Here is a model answer, with diagrams, showing how to address this type of question:
The supermarket industry could be seen as an Oligopoly, with the ‘big 4’ firms of Tesco, ASDA, Sainsburys and Morrisons dominating. The market is highly concentrated though and there are signs that one or more of the supermarkets may be able to exert monopoly power. Throughout all the period 2012-2020, Tesco held over 25% market share which is the traditional benchmark for a firm with monopoly power.
Customers interests will be poorly served in such a concentrated market with elements of monopoly power due to prices being higher and output lower than equilibrium in competitive market conditions. This is evident in extract F, where local monopolies (in towns with only one supermarket) are resulting in lengthening queues and rising prices. The reason for this outcome can be seen in a diagram, with monopoly firms profit maximizing at MC=MR, charging price Pm and producing output Qm.
This output is lower than the outcome under competitive market conditions at Qc and the price is higher than it would be at Pc. Consumers therefore lose out as the monopolist is able to extract consumer surplus and turn it into producer surplus. There is also a deadweight loss of area ABC. Extract F also mentions the reduced choice that consumers are faced with in this situation, with one or a few firms dominating the market they are deprived of the ability to shop around and access different types of groceries.
Having said this, the evidence does not all suggest that this is the outcome in the supermarket industry. Extract E says that price wars are common with Morrisons, Tesco and ASDA all cutting their prices. This may be due to the discounters showing the ‘big 4’ that new entrants to the market are possible. This increases contestability in the market and as a result, the dominant firms reduce their prices from P on the diagram, closer to the point where AR=ATC at P1.
It could equally be argued that customer interests are being well served by the sector due to the larger firms ability to benefit from economies of scale. The proposed merger between Sainsburys and ASDA was predicted to bring cost savings of £1bn per year (extract F) and all of these firms have well established delivery infrastructure (extract E). These are possibly examples of purchasing and network economies of scale. As these firms grow larger in size, these benefits enable them to lower their long run average costs. Crucially, these lower costs can then be passed on to the consumers in the form of lower prices. The reducing price gap between conventional supermarkets and discounters from 20% down to 10-12% would suggest that these cost savings are indeed being passed on.
However, all of these conventional supermarkets are vast businesses with revenue well into the billions of pounds already. It is questionable whether further growth is likely to continue bringing economies of scale, and more likely they may start to suffer from diseconomies of scale. This is when growth leads to increasing LRAC and therefore consumers may also suffer in the form of higher prices.
Overall, I think that price is the most important variable for most consumers when doing their supermarket shop, and the sector seems to be serving consumers interests fairly well on this metric. There does not seem to be a huge amount of collusion, as evidence by the price wars, and this would be the biggest potential concern in an Oligopoly market. However, maintaining a level of contestability in the market is key to ensuring these prices remain low and the incumbents in the market do not get complacent. I would therefore recommend that the CMA continue to monitor behaviour of firms in the market very closely, and would argue that they were absolutely right to block the merger between ASDA and Sainsburys for this reason.
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