Paper: January 2020 (IAL) Unit 3 Edexcel Economics A-Level
A demerger is a separation of a firm into two or more businesses.
On the one hand, a demerger might present significant benefits to consumers as it may lead
to improved consumer welfare and surplus through lower-priced, higher quality goods. This
dynamic is particularly evident in industries experiencing horizontal demergers, where
increased competitive pressures often emerge. Following a demerger, each newly
independent firm (owing to the increased threat of competition) is likely to be incentivized to
optimise its operations and to make the business leaner through improved productive
efficiency. This may have the effect of reducing the firm’s average costs of production, which
may then translate to lower prices for consumers, thus increasing consumer surplus.
Alternatively, firms may attempt to gain a competitive edge through investment in product
innovation, thus enabling for improved dynamic efficiency. This factor may enable the newly
demerged firms to cater to unique consumer demands, increasing choice in the industry and
hence, improving consumer welfare. The effects of this are likely to be intensified by the
ability of the newly demerged firms to recentre business focus, as each individual firm can
direct more effort and resources to its core business goals and strengths. This was evident
in the 2015 demerger between PayPal and eBay. After the demerger, both businesses were
able to focus exclusively on their own unique services in the e-commerce marketplace. As
such, PayPal was able to focus on its payment processing services, improving their dynamic
efficiency through investing in innovative processes for online payment. This improved
efficiency translated into lower costs which PayPal then passed on to consumers as lower
prices, increasing consumer welfare and surplus. Similarly, the investment in product
innovation enabled PayPal to offer online payment services that were unique to other
alternatives in the marker, increasing choice for consumers. As such, a demerger (through
increasing competition and leading to greater focus within a firm) may be seen as beneficial
to consumers due to the potential for improved quality, choice and price of products.
Nonetheless, in some instances, demergers may actually result in an increase in the
average costs of firms and may therefore reflect negatively on consumer welfare through
contributing to higher prices. Through horizontal demergers for example, the increased
demand for resources from the newly created firm may create increased price pressure on
the factors of production – especially if the price elasticity of supply of those resources is
inelastic. This increase in price will result in a similar increase in the costs of production of
these firms. Given that the demand for the firm’s products is inelastic, the firm is likely to
pass on these increased costs as higher prices for consumers, decreasing consumer welfare
as individuals need to spend more of their disposable income. This may also become the
case during vertical demergers, as firms may lose access to the suppliers they once were
merged with. This will force them to purchase these resources, rather than have them
produced for themselves, therefore contributing to higher costs which may translate to higher
prices for consumers. Higher average costs due to mergers may also arise due to the
A demerger is a separation of a firm into two or more businesses.
On the one hand, a demerger might present significant benefits to consumers as it may lead
to improved consumer welfare and surplus through lower-priced, higher quality goods. This
dynamic is particularly evident in industries experiencing horizontal demergers, where
increased competitive pressures often emerge. Following a demerger, each newly
independent firm (owing to the increased threat of competition) is likely to be incentivized to
optimise its operations and to make the business leaner through improved productive
efficiency. This may have the effect of reducing the firm’s average costs of production, which
may then translate to lower prices for consumers, thus increasing consumer surplus.
Alternatively, firms may attempt to gain a competitive edge through investment in product
innovation, thus enabling for improved dynamic efficiency. This factor may enable the newly
demerged firms to cater to unique consumer demands, increasing choice in the industry and
hence, improving consumer welfare. The effects of this are likely to be intensified by the
ability of the newly demerged firms to recentre business focus, as each individual firm can
direct more effort and resources to its core business goals and strengths. This was evident
in the 2015 demerger between PayPal and eBay. After the demerger, both businesses were
able to focus exclusively on their own unique services in the e-commerce marketplace. As
such, PayPal was able to focus on its payment processing services, improving their dynamic
efficiency through investing in innovative processes for online payment. This improved
efficiency translated into lower costs which PayPal then passed on to consumers as lower
prices, increasing consumer welfare and surplus. Similarly, the investment in product
innovation enabled PayPal to offer online payment services that were unique to other
alternatives in the marker, increasing choice for consumers. As such, a demerger (through
increasing competition and leading to greater focus within a firm) may be seen as beneficial
to consumers due to the potential for improved quality, choice and price of products.
Nonetheless, in some instances, demergers may actually result in an increase in the
average costs of firms and may therefore reflect negatively on consumer welfare through
contributing to higher prices. Through horizontal demergers for example, the increased
demand for resources from the newly created firm may create increased price pressure on
the factors of production – especially if the price elasticity of supply of those resources is
inelastic. This increase in price will result in a similar increase in the costs of production of
these firms. Given that the demand for the firm’s products is inelastic, the firm is likely to
pass on these increased costs as higher prices for consumers, decreasing consumer welfare
as individuals need to spend more of their disposable income. This may also become the
case during vertical demergers, as firms may lose access to the suppliers they once were
merged with. This will force them to purchase these resources, rather than have them
produced for themselves, therefore contributing to higher costs which may translate to higher
prices for consumers. Higher average costs due to mergers may also arise due to the
