Definitions:
• Oligopoly
• Horizontal merger/integration
• Who the economic agents are
Diagrams:
• Monopoly + economies of scale (A* diagram)
• Minimum efficient scale
Benefits to different economic agents of a horizontal merger
Producers
• Increased market share, providing robustness.
• Increased scale of production leading to internal economies of scale as long-run average
costs fall.
o Contextualisation: in the case of British Airways and Iberia, they may be able to
benefit from marketing economies of scale by spreading marketing costs over a
larger output, reducing per unit costs.
• By lowering costs, firms may be able to increase supernormal profits and increase producer
surplus. These profits could then be invested into more efficient capital, allowing firms to be
dynamically efficient.
• Reference to diagrams
Consumers
• Lower average costs of production may be passed onto consumers in the form of lower
prices, increasing their consumer surplus.
• The potential for firms to be dynamically efficient may mean that the quality of the
good/service enhances over time. For example, the merger may lead to technological
improvements in the design of the aircraft or the service provided by the airline, leading to
increased consumer welfare.
Drawbacks to different economic agents of a horizontal merger
Producers
• Diseconomies of scale: use the minimum efficient scale to show how, following constant
returns to scale, a firm may face diseconomies due to inefficiencies arising from increased
firm size. Examples:
Consumers:
• The merger of two large firms in an oligopoly market structure like the airline industry could
lead to the formation of a monopoly as the combined market share of the two firms will
increase. This increased monopoly power could strengthen the firm's price-making ability
and could lead to higher prices that seek profit maximisation at the expense of consumer
welfare. Analysis of diagram (KEY)
, • Further away from the allocatively-efficient point as well as productively-efficient point (dwl)
• Could become complacent with their monopoly power - leading to X-inefficiencies.
• Another economic agent, the government, would bear the consequence of having to step in
to deter anti-competitive behaviour and protect the interests of consumers. An example of
this was the CMA's decision to block the Sainsbury's and Asda horizontal merger.
• Lack of choice due to possible elimination of competition.
• This would be worsened if consumers have fewer substitutes to turn to; as the merger
would allow the firm to benefit from economies of scale, it may outcompete incumbent
firms or carry out restrictive practices that deter new firms from joining the market.
Conclusion:
• Depends on the contestability of the market in question. With an imminent threat of
competition, firms may be less likely to be X-inefficient and set higher prices. Investments
are likely to be more productive as firms will seek dynamic efficiency to remain competitive.
• The airline market is clearly incontestable with its high barriers to entry and high sunk costs.
Therefore, a horizontal merger is more likely to have negative consequences for economic
agents, especially consumers.
• Oligopoly
• Horizontal merger/integration
• Who the economic agents are
Diagrams:
• Monopoly + economies of scale (A* diagram)
• Minimum efficient scale
Benefits to different economic agents of a horizontal merger
Producers
• Increased market share, providing robustness.
• Increased scale of production leading to internal economies of scale as long-run average
costs fall.
o Contextualisation: in the case of British Airways and Iberia, they may be able to
benefit from marketing economies of scale by spreading marketing costs over a
larger output, reducing per unit costs.
• By lowering costs, firms may be able to increase supernormal profits and increase producer
surplus. These profits could then be invested into more efficient capital, allowing firms to be
dynamically efficient.
• Reference to diagrams
Consumers
• Lower average costs of production may be passed onto consumers in the form of lower
prices, increasing their consumer surplus.
• The potential for firms to be dynamically efficient may mean that the quality of the
good/service enhances over time. For example, the merger may lead to technological
improvements in the design of the aircraft or the service provided by the airline, leading to
increased consumer welfare.
Drawbacks to different economic agents of a horizontal merger
Producers
• Diseconomies of scale: use the minimum efficient scale to show how, following constant
returns to scale, a firm may face diseconomies due to inefficiencies arising from increased
firm size. Examples:
Consumers:
• The merger of two large firms in an oligopoly market structure like the airline industry could
lead to the formation of a monopoly as the combined market share of the two firms will
increase. This increased monopoly power could strengthen the firm's price-making ability
and could lead to higher prices that seek profit maximisation at the expense of consumer
welfare. Analysis of diagram (KEY)
, • Further away from the allocatively-efficient point as well as productively-efficient point (dwl)
• Could become complacent with their monopoly power - leading to X-inefficiencies.
• Another economic agent, the government, would bear the consequence of having to step in
to deter anti-competitive behaviour and protect the interests of consumers. An example of
this was the CMA's decision to block the Sainsbury's and Asda horizontal merger.
• Lack of choice due to possible elimination of competition.
• This would be worsened if consumers have fewer substitutes to turn to; as the merger
would allow the firm to benefit from economies of scale, it may outcompete incumbent
firms or carry out restrictive practices that deter new firms from joining the market.
Conclusion:
• Depends on the contestability of the market in question. With an imminent threat of
competition, firms may be less likely to be X-inefficient and set higher prices. Investments
are likely to be more productive as firms will seek dynamic efficiency to remain competitive.
• The airline market is clearly incontestable with its high barriers to entry and high sunk costs.
Therefore, a horizontal merger is more likely to have negative consequences for economic
agents, especially consumers.
