Download Question 1 US confectionery Mars received the all clear from the

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