Economics Questions and Answers
Question 1: Using a Graph, illustrate the likely effect of a merger on the welfare of society
Two or more similar business companies may decide to combine their businesses into one large company. These are what are referred to as mergers. This may be for several reasons which include an aim to compete with other companies and get as much as possible market share (Schinkelet al, 2010). Companies may also merge or combine their business in order to put together their technical skills and all other necessary resources that are likely to boost the performance of their business. However mergers may have several effects on the welfare of the society of operation.
The following gives an illustration on how mergers affect the welfare of the society.
Fig.1. Effects of mergers
A-Producer surplus B-Deadweight loss C-Transfers from consumers to producers
When the two companies merge, they form a big firm with more economies of scale especially in the cost of production. Using the graph above the initial marginal cost of production was at MC1. When the two companies merge, the cost of production reduces to MC2. This then saves cost while maintaining a high level of output. However, due to lack of competition the mergers will tend maximise their profits by raising prices from P1 to P2. This will then affect the welfare of the consumers as it will cause a reduction in consumer surplus leading to an economic deadweight loss at level B. The transfers to producers will then reduce as indicated in C.
Question 2: Factors that would affect the profitability of a merger
Referring to the previous illustration, it’s clear that the T-mobile and Orange mobile firms are likely to earn profits. One of the factors that will affect the profitability of the mergers is the ability of the firms to cut down on the cost of production (Budzinski, 2008). When merging companies for example Orange and T-mobile, are able to maintain a high level of output without the need to increase their inputs, the efficiency for the merger then increases. This then enables the merger to earn profits from its operation.
According to Budzinski (2008), mergers reduce the level of competition in the market. This therefore increases the demand for the products of that particular merger. The situation is then affects the profitability of the mergers. High demand will give the mergers an opportunity to increases the price of the products. The mergers will then be able to earn very high profits due to the reduced competition in the market.
Question 3: The Importance of Synergies in Mergers and Acquisition
Synergies in mergers are aimed to create a value higher than the cost of the merging process. Considering the previous case of the two mergers, the need to gain from the merging activity is what is what causes synergies (Farrel and Shapiro, 2001). Orange and T-mobile firms then had an objective to get an extra value that exceeds the cost the incurred in creating a merger. Synergies can therefore be in the form of revenue or cost synergies. These are usually very difficult for a firm to attain them especially in form of revenue.
McChesney and Shughart (1994) explain that revenue synergies are usually attained by selling the mergers through the sale of more products. This could be done by the sharing of channels of distribution between the two merging firms. The firms may also ensure reduced competition for them to enter new markets. Cost synergies on the other hand are attained by cutting down the production costs by means such as decreasing the overheads of the firms. This therefore may negatively affect the impact of mergers on the social welfare. When the merging firms are aiming to earn back their synergies, they will not consider what the consumers are likely to suffer like high prices (McChesney and Shughart, 1994) When the merging firms set high profit margins, the burden is then laid on the consumers an the society in general.
Question 4: How does the presence of synergies affect the chances of a merger being approved by competition authorities
According to Budzinsk and Christiansen (2007), the presence of synergies is likely to affect the approval of mergers like that of Orange and T-mobile. This is because, synergies are achieved though efficiency of the firms. This then means that merging firms with synergies will try hard to eliminate competition and maximise their profits. The economic efficiency attained will then be aimed at generating synergies and not to enhance the social welfare of the society. The competition authorities will definitely decline the approval of such mergers which are likely to result in negative social impact in the society welfare.
The case of FTC against the merger between Heinz and Gerber is a landmark case that can be used to illustrate this. FTC filed the case on the claims that the merger will dominate majority of the market with an intention to achieve high synergies which would then undermine the social welfare of the society (Farrel and Shapiro, 2001).
Budzinski, O. (2008). The governance of global competition: Competence allocation in international competition policy. Cheltenham, UK: Edward Elgar.
Farrel Joseph and Shapiro Carl. (2001). “Scale Economies and Synergies in Horizontal Merger Analysis.” Antitrust Law Journal.
Top of Form
McChesney, F. S., and Shughart, W. F. (1994). The causes and consequences of antitrust: The public choice perspective. Chicago, Ill: University of Chicago Press. Bottom of Form
Oliver Budzinsk and Arndt Christiansen. (2007). “The Oracle/PeopleSoft Case: Unilateral Effects, Simulation Models and Econometrics in Contemporary Merger Control.” Legal Issues of Economic Integration.
Schinkel, M. P., Gunster, A. M., & Russo, Francesco. (2010). European Commission Decisions on Competition. Cambridge University Press.