(2012) A Level H2 Econs Essay Q3 Suggested Answer by Mr Eugene Toh (A Level Economics Tutor)

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3. Internet or online shopping has grown rapidly in recent years. Low barriers to entry have allowed a wide range of small specialised retail firms to market their products on the internet. At the same time economies of scale have led to a small number of large internet retail companies dominating the market for other products.

(a) Explain the existence of these two different types of online retailers and which market structure best explains the market behaviour of each of them. [10]

Survival of small specialised firms

Product differentiation & serving a niche market

  1. Small specialised firms generally serve a niche market where the size of the market could be very limited - for example, the sale of customised fresh baked treats for dogs

  2. These firms typically sell very differentiated products from what is generally available in the market and therefore capture specific consumer demographics

  3. There are typically very low barriers to entry and exit for such small firms running an online retail businesses - only a website hosting service & a domain is required to start operating. This makes it easy for firms to start selling.

Monopolistic competitive

  1. A monopolistic competitive firm operates in a market with many small firms, low barriers to entry and sells differentiated products

  2. There are many of such specialised retail firms, as mentioned above, there are also low barriers to entry. They also sell differentiated products.

  3. As such, small specialised retail firms operate within a monopolistic competitive market structure

Dominance of small number of large internet retail companies

Economies of scale

  1. Large internet retail companies such as Amazon produce at a substantially high level of output

  2. This allows them to reap substantial internal economies of scale, allowing them to produce at a low cost

  3. They are then able to charge relatively low prices for many goods to consumers.

  4. These low prices of many aggregated goods thus attract consumers to purchase from them

Oligopoly

  1. An oligopoly is characterised by a few large firms dominating the industry, high barriers to entry & mutual interdependence

  2. In the large internet retail companies, there are a few large firms dominating the industry such as Amazon, Lazada & Shopee.

  3. Barriers to entry are high as they benefit from economies of scale, high startup costs (hiring & delivery fleet)

  4. They also react to each others’ pricing strategies (11/11 sales across different platforms)

(b) Increased specialisation and low barriers to entry have an impact on consumers and existing producers.

Discuss how far the traditional analysis of these economic effects applies to the growth of online shopping. [15]

How specialisation contributed to the growth of online shopping

  1. The ability to specialise occurs, when a firm has sufficiently increased in size (potentially due to online retailers being able to serve a larger international market) and therefore able to increase the scale of production, allowing specialisation to take place (division of labour towards specialised tasks in the production process) → allowing for increased efficiency and thus lower cost of production

  2. This can be demonstrated on the LRAC curve where increased scale of production will result in a fall in LRAC, allowing for lower cost of production as seen in Figure 1

  3. Ability to reap substantial economies of scale could allow online retailers to price themselves more competitively allowing them to thrive (perhaps against brick-and-mortar retailers)

How low barriers to entry contributes to the growth of online shopping

  1. There are low barriers to entry to online retailers as literally anybody with a device, purchase of a domain & web hosting service, can start selling online.
    E.g. many durian sellers also have an e-commerce platform!

  2. The low barriers to entry allows for new entrants to constantly enter the market, putting downward pressure on prices and forces existing firms to be competitive in order to stay in business

  3. This could have also contributed to online shopping growing and thriving as prices remain competitive and affordable for consumers (again, perhaps compared to brick-and-mortar retailers)

Other contributors to the growth of online shopping

Alternative objectives of firms

  1. Alternative objectives of firms could help explain the growth of online shopping

  2. Firms such as Amazon, Lazada could prioritise revenue maximisation as opposed to profit maximisation in a bid to drive expansion of the firm / to gain market share

  3. For example, Redmart (under Lazada) offers 1st-time shoppers shopping credits of up to SGD$10 to encourage them to shop online with Lazada.

  4. This could increase the number of online shoppers as a result of the firms’ bid to expand.

Demand & supply factors

  1. Beyond specialisation & low barriers to entry, standard demand & supply analysis could help explain the growth of online shopping

  2. A fall in shipping costs over the years has allowed delivery fees to fall, lowering cost of production → increasing supply → increase output

  3. Rapid adoption of ecommerce and online payment methods has changed tastes and preferences and consumers are now more inclined to shop online → Increase demand for online shopping → increase output

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