2022 SH2 H2 Prelim CSQ1 (Suggested answer)

Question 1: A winner in the pandemic – Amazon Suggested Solution and Mark Scheme (a) Compare the relative change in the retail revenue for Amazon, Walmart andHomeDeport between2010 and 2020. [2] Similarity: All three firms have seen an increase in their retail revenue between 2010 and 2020.Difference: However, the rate of increase in theretail revenuefor thethreefirms aredifferent, withAmazon experiencing the fastest increase (2,800%), followed by The Home Depot(466%) then Walmart (90%). (b) Using a diagramand a relevant elasticity concept, explain how the Amazon’s differentiation strategy[Extract 1] may have contributed to the change in its revenue. [5]● Amazon worked on differentiating their services, for e.g. priorities were placed oncustomer feedback and service were prompt [inExtract 1] andthishastheeffect ofchanging the taste and preferences of consumer towards the services provided byAmazon.● This will lead to anincreaseindemandfor their services, c.p. asshownbytheshiftfromARo to AR1 inwhereequilibriumpriceandquantitywill increase, Figure1, andhence, increase in Amazon’s revenue as shown by the area 0PoaQo to 0P1cQ1.● Their differentiation strategy promotes customer loyalty who believes that the highstandardof servicescouldnot befoundintheservicesprovidedbytheirrivals,thatisthe service offered by Amazon is not easily substitutable, and hence, the valueofPEDfor Amazon’sserviceswill belessthanone, asillustratedbytheincreaseinthegradient of the demand curve (AR1).● With PED<1, hence, Amazon could increase the price of their products/services,leading to a less than proportionate decrease in quantity demanded. Hence itsrevenue will increase.● Diagramshowingtheincreaseindemand,fall inPED(increasegradientofARcurve)and the area of increased in revenue. (c) With reference to Extract 1, explain a source of cost advantage experienced by Amazon. [2]● Thissuggeststhat technical economiesof scale(indivisibility) canbeachievedwhenAmazontapsonthelargerwarehousingfacilitiesandprocessingcapability[Extract1]and share the high costs of capital equipment over large output (in this case, theincreasing number of users/customers), resulting in a fall in the long run average cost. (d) Identify and explain two possible barriers to entry faced by the potential competitors into thee-commerce market that Amazon is in. [3]● In the case of e-commerce market, Extract 2statesthat Amazonhaduseddataonthird-party sellers that use its market-place, which is a control of key resource, toboost sales of its own-label goods.Or● Amazon usedcritical informationtakenfromdataontheir thirdpartysellersthat useitsmarket-placetoanalyseconsumers’ preferencesandwhattheyarespendingtheirmoney on which could help Amazon increase its market share and higher profits.These higher profits earned by Amazon could create a natural barrier to entry toprevent potential competitors fromenteringthemarket duetotheir lower demandofits potential rival and not being profitable.And

2 ● AccordingtoExtract 2, theCommissionalsolaunchedafreshprobeintothepossiblepreferential treatment of sellers that use the tech giant's logistics services . SuchpracticebyAmazonwill preventpotential competitorsfrommakingprofitsfromhavingfewer third-party sellers usingtheir platformtosell their goodsasthesethirdpartiesthat uses Amazon’s logisticsserviceswill alsohavepreferential treatment sellingonAmazon. (e) Discuss the likely impact of Amazon’s dominant position in the industry on society. [8] Introduction:● Amazon, being a dominant firm in the industry may have both desirable andundesirable impact on society. Body (1): Undesirable impact of dominant firms such as Amazon on society (i) HigherpricesmaybechargedtoconsumersinmarketswithdominantfirmssuchasAmazon.● With Amazon’s large market share in the industry, their dominancemight implythe industry is less competitive leading to possible abuse of market power asmentionedinExtract2. Thedemandcurvefacingthedominantfirmisdownwardsloping and the firm will have greater price setter power with the lack ofcompetitors in the industry.● WhileAmazonmaychargelower pricestoconsumersintheshortrun,however,inthelongrun, thesmaller e-commercefirmsmaynotsurvivethecompetitionoflower prices and are forced to leave the industry due to their inability to enjoyeconomies of scale to charge lower prices than Amazon. This may result ingreater marketdominanceandmarketpowerforAmazon.Amazonmightbeabletoraisepricesandexploitconsumerswelfareduetofewcompetitorsavailabletooffer alternatives to consumers.● The e-commerce market would become more allocatively inefficient asseeninFigure1abovewherethelower PEDvaluefor itsdemandwill resultinitspricesrisinghigher thanit marginal cost (MC) intheUS. Amazon, anoligopolisticfirm,will haveadownwardslopingandrelativelyprice-inelasticdemand(AR)curveasseeninfigure1, andhavethesignificantabilitytosetprices.Aprofit-maximisingfirmwill produceat anoutput QmwhereMR=MCat pricePm.Thisisbecauseat output beforeQm,MRexceedsMCandthuseachadditional outputofthefirmadds more to revenue than to cost and thus increases the firm’s profits. Aprofit-maximising firmwill thus increase production till Qmwhere MR=MC. Atoutput levelsbeyondQm, MCexceedsMRandthusaprofit-maximisingfirmwillnot producebeyondQmaseachadditional outputbeyondQmreducesthefirm’sprofitsinstead. Infigure1, thefirmhasrestrictedoutputtoQminordertochargerelatively higher pricesat Pm. At output Qm, thefirmisalsolikelytobemakingsupernormal profits indicated by the area PmxyAC. It should be notedthat theprice Pm is at a significant mark-up above the MC at output Qm due to therelatively price-inelastic firm’s demand curve, which indicates the significantprice-settingabilityof adominant firm.Thishadhadtoallocativeinefficiencyanda deadweight loss to society (area xab).

3 Figure 1: Price and Output of Firm in Market with Significant Barriers to Entry ● Therewouldbelesschoicesfor consumerssincethevarietyofproductswill alsofall. Dominant firms may also not have the incentive to innovate, againhurtingconsumers welfare. (ii) Dominant firms such as Amazon could be x inefficient.● Dominant firms could also be X-inefficient. This may occur when the dominantfirmbecamecomplacentduetolackofcompetitionandhenceproduceatahigheraverage cost instead. It will not beproducingonitslongrunaveragecost curve.Without thecompetitivepressureonprofitmargins,thedominantfirmcouldbelaxabout cost controls, it could over-renumerateitsstaff bygivingthemhugeperksand bonus packages or hire more staff than necessary.● The firm produces at a cost that is above their long run average cost and stillcontinue to make supernormal profits in the long run because of thebarrierstoentry that limited competition in the market. The firm is said to suffer fromX-inefficiency. (iii) Dominant firms may lead to greater inequity● WithAmazon’sabilitytosethigherpricesandabilitytoenjoyinternal economiesof scale, Amazon can earn supernormal profitsinthelongrunduetothehighbarriers to entry it set up as mentioned in part (d).● Amazon is owned by a select few, namely the shareholderswhichmakeupaminority of the population. Hence, if Amazon continues to earn supernormalprofitsinthelongrunanddividendsarepaidtotheshareholdersattheexpenseof consumers. Wealthwouldbeconcentratedat thehandsof theshareholderswho are initially alreadybetter off thanthemajorityof thepopulation. Extract 2mentioned that Jeff Bezos, founder of Amazon, becametherichest manintheworldwithafortuneof morethan$200bnafterthefirm'ssharepricerocketedinthe early months of the pandemic.● Thisleadstoagreaterincomeinequalityandthus,maycauseunfairdistributionof economic welfare, leading to greater inequity, at the expense of consumers. Body (2): Desirable im