For this answer, like with any other essay question, I encourage my students to draft an essay plan prior to writing. By doing so, my students show me their strengths and weaknesses which allows me to tutor those areas which they have not fully mastered yet. After discussing the essay plan, I encourage my students to write their full answer that is to be marked by me.
A typical essay plan would look like this:
Define oligopoly, provide a simple example (do not re-use). Oligopolies can be good, lead to greater economies of scale(diagram), increased profits used for R+D and thus better quality products/new products e.g. supermarkets, phone makers.
But oligopolies can also be bad. This is when instead of acting competitively, firms begin to collude. Collusion can take many different forms but either way it leads to oligopolists forming a complex monopoly (when there are several firms with monopoly powers acting as one monopoly firm). One negative effect due to the resulting inefficiencies (allocative, X-, productive, draw diagram to show) but the other stems from the anti-competitive behaviour of oligopolists which want to retain their market share (e.g. price-fixing, exclusive dealing).
This forces the Competition and Market Authority (CMA) to evoke measures controlling the activities of oligopolists.
One such measure is the policing and fining of colluding companies (e.g. Virgin Airways, UK private school cartel) reinforced by punishing managers via Criminal Law (as practiced in USA, insider trading etc.).
This leads to increased competition by encouraging firms to act competitively rather than colluding whilst still maintaining existing economies of scale and with it all positive effects of oligopolies (explained in paragraph 1) + act as a deterrent to other oligopolists.
But: a) Difficult to administer, often takes years to prove collusion (if at all) at which point damage already done,
b) Agencies can prove to be overly zealous in their prosecution of innocent firms,
c) Collusion still persists so the deterring effect is weak and insufficient to effectively deal with oligopolies.
Another measure is to forcibly break up oligopolies by means of privatisation (forcing firm to split into smaller private ones) or nationalisation (In the past, BBC).
This will result in increased competition but decrease the Economies of Scale. Can be good (Nationalisation of National Grid) but also bad. A trade-off between Static and Dynamic Efficiency would occur, (Diagram to show) thus leading to adverse effects on R+D possibilities, limiting innovation and potentially forcing consumers to pay a higher price than originally. E.g. US vs. IBM trying to force them to split into smaller units, US vs. Microsoft trying to split Internet Explorer from Windows. (Difficult to administer innovative effects on a market)
Ultimately, any interference of the sort with the market mechanism will lead to a distortion from the natural equilibrium point, for better or for worse. What will be the effects on international competitiveness of UK firms if we were to prosecute our firms more strictly than other countries? The market failure becomes replaced by a potential government failure. Any interference always prone to the law of unintended consequences.
Final option is the use of preventive measures such as restricting merger activity and removing barriers to entry. This includes the removal of red-tape costs and legal barriers to entry e.g. Royal Mail revoked the status of legal monopoly.
This will lead to increased competition by allowing more firms into the market whilst maintaining existing Economies of Scale. As a result, consumers benefit from all positive effects of the former. Innovation is also encouraged through new entries to market.
But: a) regulatory capture can occur (if unsure, look up the term, provide examples)
b) Agencies can act overzealous and prevent mergers where they shouldn’t.
No single policy is without flaw. As such, a mix of preventive and punitive policies should be used. Which policies used, should be determined based on the effectiveness of individual policies and their resulting consequences (intended and unintended). Finally, it is important to remember that interference with the market is not always necessary.