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Question 1 US confectionery Mars received the all clear from the European Commision to buy the number one chewing gum maker Wrigley in a deal worth EU15 billion. Their competitors are concerned whether this could give Wrigley an unfair advantage over them. (a) (b) Explain the price and output decisions of confectionery producers in Europe. [10] Discuss the likely economic effects of this merger of two leading confectionery producers. [15] (a) Introduction - Identity type of market structure – oligopolistic - Justify type of market structure o Few large firms - Identify key feature of oligopolistic market o Interdependency of firms’ behaviour Body - All firms, including oligopolistic ones, make price and output decisions to maximise profits o Profits = Revenue – Cost o Condition for profit maximisation is MR = MC - However, oligopolistic firms have to consider the likely reaction of competitors when making pricing and output decision - Pricing and output decisions of oligopolistic firms can vary o Competitive oligopoly In situations where competitor firms are expected to match price cuts but not follow price increases, oligopolistic firms will face a kinked demand curve with resultant price rigidity in the market. (Elaboration of kinked demand curve model using diagram) Alternatively, in situations of rapidly changing market conditions (e.g. recession, technological break throughs or newly formed markets), firms may wage price wars, i.e. under-cut competitors prices, in an attempt to maximise long-run profits by winning market share and forcing competitors out of business. o Collusive Oligopoly Oligopolistic firms may come to an agreement to maximise joint profits by forming a cartel Cartels practice monopoly pricing where quantity produced is restricted and price is set above MC. (Elaborate monopoly pricing using diagram) Alternatively, oligopolistic firms may choose to follow a “price-leader” in the dominant-firm or barometric price leadership model. Conclusion - Price and output decisions of firms is based on profit-maximisation motive. However, different pricing and output outcomes can arise in oligopolistic markets depending on the behaviour of competing firms. L1 Knowledge, Application, Understanding, Analysis Lack of use of economics framework - Profit maximisation motive of firms - Interdependency of oligopolistic firms’ behaviour - Various pricing models 1–4 Failed to identify that price and output decision of firms dependent on competitors behaviour L2 Provided an explanation of how oligopolistic firms make price and output decisions based on the behaviour of competitors - Lacked in-depth explanation - Some errors in elaboration 5–6 L3 Provided an in-depth explanation explanation of how oligopolistic firms make price and output decisions based on the behaviour of competitors - Well-drawn and explained diagrams - Clear and sound elaboration 7 - 10 b) Introduction - “Economic effects” of merger could be categorised as follows: o Efficiency Productive Allocative o Equity o Innovation / Dynamic Efficiency o Consumer Choice - (Alternatively, “economic effects” could be analysed along the lines of effects on producer, consumer, society as a whole) Body - Efficiency (Allocative) o The merged entity will command a greater market share. This would allow the merge entity to practice monopoly pricing more effectively o P > MC to a greater extent, DWL also increases, signifying greater allocative inefficiency. o (Elaboration using diagram) o However, there might be less use of wasteful use of resources in creating perceived differences in confectionery products given that there is less competition in the industry - Efficiency (Productive) o Merged entity could reap iEOS. o Marketing EOS, Technical EOS. o However, there could be iDOS arising from merger such as difficulty in managing and coordinating large business operations o Merged entity could be X-inefficient given that a less competitive oligopolistic maket allows the confectionery firms to make greater supernormal-profits - Equity o Greater market power and iEOS allows firms to reap more profits. Given the entry barriers present in oligopolistic confectionery market, it is likely that firms would make greater supernormal profits. o This leads to greater inequity in distribution of income as the higher profits is obtained partly through appropriating consumers surplus - Innovation / dynamic efficiency o The merged entity would have more financial resources (owing to combined resources and facilities as well as greater super-normal profits) to undertake R&D. Ability to undertake R&D, create innovation and bring about dynamic efficiency is enhanced o However, the merged entity may not have the incentive to undertake R&D given the fact that there is lesser competition and higher entry barriers after the merger - Consumer choice o There is likely to be a reduction in consumer choice as merged firm is likely to rationalise product range to reap iEOS o Moreover, there is less need to produce differentiated products given that there is less competition in the industry o Merged entity is likely to drive out smaller firms due to the revenue and cost advantages it enjoyed. Hence, consumer choice is further reduced o However, it is possible that oligopolistic firms engage in product differentiation to crowd shelf-space and deter entry of new firms. Conclusion - Merger of Mars and Wrigley will reduce competition in the confectionery industry which brings with it many undesirable economic effects. Although it is possible that consumers could benefit from resulting iEOS and dynamic efficiency gains, it is unlikely given the profit-maximising nature of firms. Such gains are likely to be retained as supernormal profits rather than shared with consumers. Hence, it is important that consumer bodies play an active role in monitoring the activities of such dominant entities, with support from the government. L1 Knowledge, Application, Understanding, Analysis Lack of use of economics framework / concepts in analysis - Use of efficiency, equity, innovation and consumer choice as benchmark for discussing economic effects of merger 1–5 Lacks scope of coverage - Did not cover effects on various parties – consumers, producers, society - Did not cover desirable / undesirable economic effects L2 Use of appropriate framework / concepts in analysis 6–8 Some elaboration of key ideas Sufficient scope of coverage - Covered effects on various parties – consumers, producers, society - Covered desirable / undesirable effects L3 In-depth discussion of the economic effects of merger with appropriate framework / concepts with sufficient scope - Well-drawn and explained diagrams - Clear and sound elaboration 7 - 10 E1 Evaluation of the likely economic effects. For example, an evaluation of whether consumers likely to gain or lose in terms of consumer choice. 1-2 E2 Evaluation of likely economic effects with justification 3-4