Case Study Question 1

(a) (i) Account for the sharp increase in cocoa prices. [5]
 Fall in supply due to “dry weather, pests and swollen-shoot disease” in Ivory
Coast, which provides a third of the world’s cocoa beans and bad weather in
Indonesia, the world’s third largest producer, and Ecuador, the seventh largest
 Increase in demand due to increased demand for “upmarket chocolate that has
a higher cocoa content” and “cocoa … being used for financial investment” (i.e.
higher demand due to speculation of higher future prices)
 Fall in supply and increase in demand  increase in cocoa prices
 As supply of cocoa is price inelastic due to “stocks are at an all-time low” and
gestation period, and demand for cocoa is price inelastic due to lack of
substitutes for cocoa beans as raw materials for chocolate and coffee
production  sharp increase in cocoa prices
 <Insert diagram>

(b) With the help of a diagram, explain how “setting a minimum price for cocoa can
make farmers less vulnerable to market oscillations”. [4]
 Explain how setting a minimum price/ price floor will create a surplus of QD – Qs.
 The government could buy the surplus or provide subsidy to guarantee the revenue
earned by the cocoa farmers.
 The minimum price will make farmers less vulnerable to market oscillations as any
changes in demand will not affect the revenue earned by the farmers, assuming that
the resultant equilibrium price is still below the minimum price. However, if supply falls
or increases, revenue earned will fall and increase respectively.

Price ($)

Supply
P min

P* •E 0

Demand
0 Quantity of cocoa
QD Q* QS

(c) State and justify the type of market structure operating in the confectionery sector. [3]
 Oligopoly
 Justification:
- Extract 2 – Collusion (price-fixing) due to mutual interdependency
- Table 1 – A few large firms dominating the market (5 large companies holding
55.5% of market shares)
- High barriers to entry in terms of branding (e.g. Cadbury’s strong brands in Ext 3)

(d) As an economic advisor to the British government,

(i) assess the impact of the takeover of Cadbury by Kraft Foods. [10]

Impact on producers:
Positive impact:
  Reduction in costs (Extract 4 “savings in things like procurement, on how
we source cocoa, dairy, sugar, packaging and advertising”)
 Gain a larger market share and increase revenue (Extract 3 “create a giant
with $50 billion in yearly revenue, spanning the world from the United
States and Mexico to Britain and India” and “give it a global distribution
network”)
 These should result in higher profits and increase producer welfare of Kraft

Evaluation/Negative impact:
 Other confectionary companies might engage in more non-price competition if
they view the takeover as a threat.
 Dealing with “public dismay at the sell-off of such an iconic British brand”.

Impact on consumers:
Positive impact:
 Cost savings may be passed on to consumers in the form of lower prices
 Increase in global distribution network might result in greater choices, leading to
increase in consumer welfare
 Since the confectionery sector is “increasingly competitive”, the takeover might
result in more profits and greater ability to invest in R&D to innovate, leading to
new products and more choices.

Evaluation/Negative impact:
 Higher possibility of price-fixing due to less competition and greater market
power; exploitation of market power leading to higher prices and/or less variety
of goods produced.

Overall impact on economy/society:

 The takeover could lead to “increase manufacturing jobs in the UK” as Kraft
“vowed … to invest in … Cadbury and create more jobs”. However, in its costs
savings drive, it might streamline its production process and lay off workers. On
the other hand, if the government does not allow the takeover, there might still
be job losses as “Cadbury had been cutting jobs at its two major plants in
Britain” and “Cadbury has limited opportunity as a stand-alone entity in this
increasingly competitive environment”, indicating that Cadbury might not remain
profitable, leading to an eventual shut-down and loss of jobs.
 If the takeover results in an exploitation of market power, there will be greater
allocative inefficiency
 If market power is exploited, there could also be greater inequity if Kraft reaps
excessive profits at the expense of consumers and other firms.
 If the takeover results in Kraft having greater ability to carry out R&D due to cost
savings, there will be greater dynamic efficiency

Conclusion
 The takeover could generate both costs and benefits to producers, consumers
and society, depending on:
> how much the market power of Kraft increases or on the reduction of the
level of competition in this market
> whether Kraft fulfils its promise to invest more in Cadbury and create more
jobs
> whether the government has put in place appropriate policies to deal with
possible anti-competitive behaviours
 Make a judgment and substantiate it

Level Descriptors
L1 A few valid points made incidentally in an irrelevant context
1–3 OR: Largely only stating impact without any explanations
OR: Focus on explaining costs and benefits of takeover not within
context (for example discussion of EOS and DisEOS)
 OR: Well-explained impact on only 1 group (consumer, producer or
society)
L2 Briefly explained impact on at least 2 groups. Little or no use of case
4–6 material
OR: Well-explained impact on at least 2 groups. Balanced argument
which considers both positive and potentially negative effects. Good
use of case material
L3 Well-explained impact on all 3 groups
7–8 Balanced argument which considers both positive and potentially
negative effects. Consistent use of case material to support answer
E Mainly unexplained judgment about the impact of the merger of
1–2 networks (Attempt to consider which group benefits more or whether
there are more positive or negative effects)

(ii) evaluate the possible policies to reduce/ prevent the detrimental effects
caused by the behaviours of the confectionery companies. [8]

Candidates are expected to address the detrimental effects identified in part(d)(i)

Anti-trust policies:
 Detrimental effects: Exploitation of market power leading to higher prices,
inefficient allocation of resources and/or anti-competitive behaviours (such as
collusion, predatory pricing)  Loss in consumer welfare
 Anti-trust policies are programmes designed to prevent the deliberate creation
of monopolies, and to prevent dominant firms from engaging in anti-competitive
practices. Government agencies can take firms accused of such behaviours to
court, forced it to be split up and/or impose penalties such as fines (Extract 2
“companies could be fined up to 10 per cent of their annual turnover”).
 However, whether a firm has breached an anti-trust policy is rarely a clear cut
case.
 Moreover, sometimes companies merge or takeover another company not to
reduce competition but to lower costs through more efficient joint production.
The lower cost can benefit the consumers.

Regulation through lump-sum taxes

 Detrimental effect: greater inequity if Kraft or other confectionery companies
reap excessive profits at the expense of consumers and other firms
 A lump-sum tax can be used to reduce this excessive monopolistic profit. A
lump-sum tax is a tax fixed in amount and levied without any regard to the
output or revenue of the firm. It can be regarded as a fixed cost to the firm and
therefore shifts the AC curve upwards. If the government uses the tax revenue
earned to subsidise the lower-income families, inequity issues can be further
reduced.
 <Insert limitations>

Supply-side policies (to deal with loss of jobs)

 Detrimental effects: Loss of jobs if the “increasingly competitive environment”
resulted in extensive costs-cutting/ streamlining measures and/or if firms start
making losses and shut down.
 Market-oriented manpower policies such as reducing the power of trade unions
and promoting greater mobility in the labour markets and flexibility in wages to
enable those who have lost their jobs to find a new one.
 Interventionist policies such as providing incentives for workers to go for
retraining and/or improving transport infrastructure to allow greater mobility of
factors.
 <Insert limitations>
Conclusion
 Will government intervention necessarily lead to a more desirable outcome?
Possibility of government failure?

Level Descriptors
L1 Weak or insufficient analysis of at least 2 policies. No or little attempts
1–3 to consider the limitations of the policies. Some application to context.
OR: Good analysis of only 1 policy with application to context.
Limitation of policy is considered.
OR: Good analysis of at least 2 policies with limited application to
context and/or minimum consideration of limitations.
Might not link to the detrimental effects identified in part(d)(i)
L2 Good analysis of at least 2 policies. Good application to context.
4–6 Limitations of policies are considered.
Must link to the detrimental effects identified in part(d)(i)
E
1–2 Judgment based on analysis and well-substantiated