ChainWhat it assumes · how to break it
Start
Two large rivals in an oligopoly merge, for example two supermarket chains combining their stores and supply chains.
1
As a result, the merged firm produces on a larger scale and can spread fixed costs, such as IT systems and distribution networks, over more output.
economies of scale
economies of scale
Assumes: The firms were operating below minimum efficient scale.
But: If both firms were already at minimum efficient scale, extra size brings no cost savings and may bring diseconomies of scale.
2
This means average cost falls towards the lowest attainable cost, so productive efficiency improves.
productive efficiency
productive efficiency
Best link to attack
Assumes: The cost savings last once the merger is complete.
Assumes: The cost savings last once the merger is complete.
But: With one fewer rival, competitive pressure weakens and managers may let costs drift up, so X-inefficiency eats into the savings.
3
At the same time, the loss of a close rival gives the firm more market power, so it sets price further above MC and allocative efficiency worsens.
allocative inefficiency · deadweight loss
allocative inefficiency · deadweight loss
Assumes: The firm uses its extra market power.
But: If the market is contestable or buyers are powerful, the firm cannot raise price far above MC.
End
Productive efficiency may improve through economies of scale, while allocative efficiency is likely to worsen as price rises further above MC.
Evaluation chain
- E1However, the productive efficiency gain depends on the cost savings lasting once competitive pressure has fallen.
- E2If the merged firm faces fewer strong rivals, then its managers have less need to keep costs down.
- E3As a result, organisational slack builds up over time and AC rises above the lowest attainable cost, reversing part of the early saving.
- E4So a merger is likely to improve efficiency only where strong rivals or a contestable market keep up pressure on costs; otherwise both productive and allocative efficiency may end up worse.
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Questions this answers
- Assess the effects of horizontal mergers on economic efficiency.
- Explain how a merger might lead to productive efficiency.
- Discuss whether competition authorities should allow mergers that create economies of scale.
Diagram
Williamson trade-off diagram: the merger lowers AC (and MC) from AC1 to AC2 but raises price from the competitive level; compare the cost-saving rectangle with the deadweight loss triangle. Show X-inefficiency as AC drifting back above the lowest attainable cost.
Reverse and related
Demerger or blocked merger → more competition and allocative efficiency, but lost economies of scale.