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2281 · 3.5

Firms — practice questions

Practice and worked examples for 2281 Firms. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

Firm A (supermarket chain) is considering three growth options:

(i) Opening 20 new stores using retained profits (ii) Taking over Firm B, another supermarket chain (iii) Taking over Firm C, a logistics company

(a) Classify each option. (b) Evaluate one advantage and one disadvantage of option (ii).

Show solution outline

(a) (i) Internal (organic) growth — reinvesting profits to expand capacity in the same business.

(ii) External horizontal merger — takeover of a rival at the same production/distribution stage in the same industry.

(iii) External vertical merger (backward) — takeover of a supplier/distribution partner in the supply chain.

(b) Option (ii) — horizontal takeover:

Advantage: Economies of scale — combined purchasing power, shared IT systems, and reduced average costs. Also increased market share immediately.

Disadvantage: Competition authority may block the merger if it creates excessive market power, harming consumers through higher prices or less choice. Integration of two large organisations also risks diseconomies of scale (management coordination problems).

Worked example 2

The smartphone market in a country has a total annual revenue of $500 million. The top two firms, 'Connecta' and 'Mobilize', are considering a horizontal merger. Connecta has annual revenue of $150 million, and Mobilize has annual revenue of $100 million.

(a) Calculate the initial market share of Connecta and Mobilize. (b) Calculate the combined market share of the new firm if the merger proceeds. (c) Using your answer to (b), explain why a competition authority might investigate this merger.

Show solution outline

(a) Initial Market Share Calculation

Market Share = (Firm's Revenue / Total Market Revenue) × 100

  • Connecta's Market Share: ($150 million / $500 million) × 100 = 0.3 × 100 = 30%

  • Mobilize's Market Share: ($100 million / $500 million) × 100 = 0.2 × 100 = 20%

(b) Combined Market Share Calculation

  • Combined Revenue: $150 million (Connecta) + $100 million (Mobilize) = $250 million

  • New Firm's Market Share: ($250 million / $500 million) × 100 = 0.5 × 100 = 50%

(c) Reason for Investigation

A competition authority would likely investigate this merger because the new combined firm would control 50% of the market. A single firm holding such a dominant market share is considered to have significant market power. This could lead to a substantial lessening of competition, potentially resulting in higher prices, lower quality, and less choice for consumers. Regulators would be concerned that the merged firm could act like a monopoly, harming consumer welfare.

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