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Economics

Practice Exam Questions

Mergers and Consumer Welfare (Revision Essay Plan)

Level:
A Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Here is a suggested essay plan answer to this question: “Using your own knowledge, assess the extent to which mergers such as Amazon integrating with Whole Foods are likely to be in the interests of consumers. Use diagrammatic analysis to support your answer.”

Mergers and Consumer Welfare (Revision Essay Plan)

There is growing discussion about whether the market power (broadly defined) of many of the tech giants should now come under greater scrutiny and perhaps whether they should be broken up.

Background: (Not part of the suggested answer)

In 2017, Amazon agreed a £10.5bn acquisition of Whole Foods, a food retailer that specialises in selling organic foods. The deal has raised concerns about the effects of increasing market concentration in a variety of US industries, including food retailing, airlines, banking and telecommunications.

  • Amazon is the worldwide largest online retailer with a range of more than 250 million different products.
  • Amazon's market share in the U.S. online commerce market was 49 percent in 2018.
  • Half of US households are subscribed to the membership programme Amazon Prime
  • Half of all online shopping searches start directly on Amazon as they mount a serious challenge to Google in online search
  • Amazon has 32% of cloud computing revenues (AWS)
  • Amazon is the largest online seller of footwear and apparel
  • Whole Foods Market is an US-based based grocery retailer with an emphasis on organic and natural food products.

KAA Point 1: Sales growth and lower consumer prices

One argumentthat Amazon’s integration with Whole Foods might be in the interests of consumers is that their main objective is fast growth and thisleads to lower prices and increased consumer surplus. One objective of a business might be Growth (or Sales) Max atanoutput where AC=AR and only normal profits are made. Whilst Amazon does not target specific outputs, their drive to increase sales can be shown on a cost and revenue diagram and we can illustrate how consumer surplus is higher than with profit maximisation.

Consumer surplus with different business objectives

EVAL Point 1: Decline in local competition & high street

A counter argument is that the market power of Amazon is having a negative impact on other competitors and suppliers, andalso on consumers. Many jobs have been lost in businesses that have closed in the face of Amazon’s growing power including Toys R Us. Smaller retailers are unable to cope with the low-cost strategy of Amazon and there are fears that Amazon is a factor behind the decline of the High Street.Smaller grocers don’t have the financial resources to invest in technology and compete with Amazon Fresh.

KAA Point 2: Economies & scale and dynamic efficiency

A second argument that mergers can be in the consumer interest is that, whilst monopolies in theory are not ideal, in reality, Amazon’sinternal economies of scale and hyper efficiency in purchasing, logistics and delivery has lowered their LRAC and increasedthespeed and reliability of their services. They are now investing heavily in drones especially in urban areas. Gains in productive and dynamic efficiency can improve outcomes for consumers. My analysis diagram shows the benefit for consumers from internal economies of scale.

Economies of scale can lead to lower prices and higher profits

EVAL Point 2: Monopsony power and tax avoidance

In evaluation,Consumer welfare can be diminished when dominant businesses such as Amazon use their monopsony powerin markets to lower prices paid to suppliers (consumers work for these businesses too) and (in theory) play lower wages to their warehouse employees than if the labour market was more competitive. Employees and suppliers are key stakeholders in a discussion about market power and welfare. Amazon benefits from lower costs and higher profits but tax avoidance is now a huge issue.

FINAL CONCLUSION

There is a trend towards oligopoly in many industries and the Amazon - Whole Foods merger is a good example of consolidation that has increased the market power of one of the world’s biggest businesses. Mergers tend to increase market power which in theory allows companies to increase profits by hiking prices. The key is whether the efficiency gains that come from economies of scale are eventually passed down to consumers through lower prices. It is important to judge each business and each industry on a case-by-case basis. Although in many ways, Amazon is dominant in the United States (for example Amazon's market share in the U.S. online commerce market was 49 percent in 2018 and half of US households are subscribed to the membership programme Amazon Prime) but in reality their share of the US grocery market remains less than 5 per cent, and the industry is also being shaken up by the fast growth of deep discounters such as Aldi and Lidl.

On balance I would argue that Amazon’s low price strategy and heavy investment in logistics and service innovation is good for consumers in the long run and provides a benchmark for other retail businesses to aim for. However, the impact of monopsony power on wages is a concern and so too are the ways in which large corporations are able - for example through shadow pricing - to reduce their tax liabilities. Overall, provided a market is contestable, firms with market power will deliver value to customers because of the threat of competition. Amazon looks unassailable at the moment but the retail industry is a dynamic one and their market dominance cannot be assumed to be permanent.

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