Monday, October 13, 2008

What Happens If GM succesfully merged with Chrysler?

Benefits for GM if acquisitions of Chrysler materialise

(1) Economies of scale. EOS is defined as fall in the long run average costs curve associated with an increase in output. GM may enjoy purchasing EOS, technical EOS, financial EOS etc. Purchasing EOS is when GM purchase inputs in huge bulk, thereby giving them advantage of negotiating for lower price. Financial EOS is achieved when it borrows in a big sum. This gives them an edge over negotiation for lower financing rates. Furthermore banks would not hesitate to borrow given that larger firm is perceived as more stable & more cash-rich. Technical EOS is when production plant is used to the maximum capacity, thereby spreading over large fixed costs

(2) Enlarge its market base. The resulting company will conquer larger US market share. This is because GM is the leading car manufacturer & Chrysler is the third. Having more monopoly power, may enable it to charge higher price in the future once the economic woes settle back. This leads to greater supernormal profits

(3) Greater R&D. Earning supernormal profit in the long run, enable the resulting larger firm to invest larger portion of its retain profit into R&D. By doing so, it may lead to discovery of better production techniques or innovation e.g. more fuel efficient cars. Consumers are the biggest beneficiaries on this

(4) Less need for advertising & branding. Chrysler has strong brand equity & large customer base. GM does not need to engage in heavy promotion or advertising to push for more sales

Disadvantage of the acquisitions

(1) Allocative inefficiency. Having monopoly power, the new firm will charge customers the price where MC = MR, rather than P = MC or MC = AR resulting in allocative inefficiency. By charging higher price there is also a loss of consumer surplus

(2) Productive inefficiency. The new firm having monopoly power will not produce output where LRAC is minimised rather output at MC = MR

(3) Diseconomies of scale. DEOS is increase in the costs of production associated with the increase in output. As size of operation increase, more bureaucracy will be involved when layers of management/ department added. This adds to cost. Also it will be more difficult to monitor large number of workers. Failure in communication often leads to strike that increase the costs of operation (depending how long). For big firms, these are normal problems

(4) Easier for collusion. As number of firms shrinks, this causes the car industry to be more concentrated. In other words, having high concentration ratio (normally we use CR3-5). This gives the new resulting firm more space to practice collusion with other firms, practice of selling cars at higher price

(5) Job losses. As the mergers will involve restructuring of operation, more workers will be retrenched as part of the plan to cut costs. This will add to the gloom of US economy which is already on the brink to Great Depression

(6) Lower price to suppliers of inputs. The resulting new firm can pressed suppliers to supply raw materials or inputs at much lower price as it has monopsony power. The same argument goes for Tesco that pressurised farmers to supply to them those vegetables at a very low price. However, GM may argue that this is for the benefits of consumers too as lower costs may translate to cheaper car

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