Discuss how far increased specialisation and low barriers to entry apply to the growth of online shopping. [15]

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.

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]

An economics student’s response to the H2 ‘A’ level Economics November 2012 Essay Question 3

Part (b) of the H2/ A level Economics N2012 Essay Question 3 is kindly contributed by WYWS

This paper argues that while increased specialisation and low barriers to entry are able to account for the growth of online shopping, there exist other equally important theories in which the online shopping industry could expand. These other ways include online shopping retailers growing internally by expanding over time, or by growing externally by integrating with other firms via mergers, acquisitions and takeovers. Besides growing, alternative theories of firms postulate that aside from maximising growth, real world firms may aim to maximise profits or revenue.

Increased specialisation refers to the division of labour, and thus economies of scale. In the long run, rational profit-maximising firms aim to produce at the minimum efficient scale (MES), the point where the long run average cost (LRAC) curve shops falling, or where economies of scale are first exhausted.

Draw relevant economics diagram here – what diagram should be drawn?

This aim allows the firms to minimise the possibility of being undercut by their competitors, while giving them the ability to undercut their competitors. By reaping economies of scale, firms are also able to obtain cost advantages unavailable to their competitors, which allows them to lower their cost of production, produce more output, and thus increase their profits. A form of division of labour could be dividing one software engineer’s job of maintaining the integrity of the website and formulating creative new ways to improve the website into a job for two people, such that each could focus more intensively on their job scopes, thereby resulting in a higher quality and quantity of output. By increasing specialisation, firms could therefore reap economies of scale and ultimately promote growth.

Besides increased specialisation, low barriers to entry could also lead to the growth of firms in the online shopping industry. Entrepreneurs are decisive risk takers, who seek to coordinate the factors of production of land, labour, and capital, to bring out an increase in output from a given input. Low barriers to entry – both artificial and natural – allow potential entrepreneurs to capitalise profitable opportunities by providing easy access into these profitable segments of the market. The entry of new competitors would therefore apply pressure on incumbent firms, lowering output prices, and improving the overall allocation of resources. Low barriers of entry and exit of the market would therefore ensure that firms which are efficient and producing in accordance to market demand would survive and prosper in the market, while firms which are inefficient and whose production are not geared to the market would face their demise.

Other than increased specialisation and low barriers to entry, firms in the online shopping industry could grow by expanding internally over time or externally by integrating with other firms. There exists three types of integration, namely horizontal, vertical and conglomerate integration. Horizontal integration occurs when two firms that are producing the same product, or are engaged in the same stage of production, combine to form one entity. Vertical integration occurs when a firm in a stage of production combines with another firm from another stage of production, and consists of forward and backward integration. Forward integration occurs when a firm integrates with another firm at the next stage of production. Backward integration occurs when a firm integrates with another firm at an earlier stage of production. E-commerce oligopoly Amazon for instance, would have undergone vertical integration, as it does not only provide the service enabling consumers to search for products online, but also handles the logistics of delivering the product to the consumer’s doorstep. Conglomerate integration occurs when a firm mergers or acquires another firm from an unrelated industry.

Aside from expanding internally or externally, there exists several alternative theories of the firm which theorise that firms maximise profit and revenue, besides maximising growth. Maximising sales revenue increases the firm’s market share, which increases the prestige of the firm’s managers. Maximising growth via maximising output incurs additional costs such as advertising, investment, and research and development, but this would pay off in the long run with an expansion of demand and capacity. The behavioural theory of the firm by Cyert and March uses Herbert Simon’s theory of bounded rationality necessitating satisficing to argue that real world firms aim for satisficing behaviour, and proved this with real world empirical data. Satisficing refers to managers aiming to achieve other objectives by maintaining a satisfactory level of output to keep shareholders happy, rather than maximising growth. The managerial theory of the firm by Baumol and Williamson argues that managers seek to maximise their own utility rather than maximising growth. Bearle and Means argued regarding the ownership and control of the firms, where ownership of the firm is often spread over a large number of shareholders, and conversely control of the firm is often in the hands of a few managers.

Draw relevant economics diagram here – what diagram should be drawn?

According to the diagram above depicting a monopoly, firms can choose to maximise profit, revenue, or output, all of which would result in different levels of P and Q to be chosen, depending on the aims and objectives of the mangers. To maximise profit, managers aim to produce at marginal cost (MC) = marginal revenue (MR), at price P1 and output Q1. To maximise revenue, managers aim to produce where MR=0, at price P2 and output Q2 and still earn supernormal profits. To maximise growth, mangers aim to produce at average cost (AC) = average revenue (AR) and earn normal profits. Hence, applying this to oligopolies and monopolistic competitive firms in the online shopping industries, these firms could choose to maximise profits or revenue instead of maximising growth.

In conclusion, traditional analysis of increased specialisation and low barriers to entry are not as effective as alternative theories of the firm in analysing the growth of online shopping. The reason being is that the online shopping is a relatively new concept, since many consumers only have access to fast, reliable Internet post 20^th century. Therefore, imperfect information largely exists in such industries as compared to real world industries such as agriculture, thereby rendering traditional economic theories on the growth of the former being less accurate and reliable to alternative theories of the firm. However, these traditional analysis are still useful in certain cases, and therefore it is vital to keep them in our economic analysis toolkit.

JC Economics Essays – Special thanks to WY for his excellent contribution of a well-argued, well-written, and clearly-worded economics essay on the H2 / A level economics November 2012 examination essay question on market structure, economies of scale, barriers to entry, alternative theories of the firm, and internet retail firms.

Covering a lot of good economics material, this exemplary economics essay is an excellent model essay on how to effectively tackle examination questions. It succeeds greatly by using various economic theories and examples, and relevant economics diagrams, all targeted at making a reasoned, reasonable, and rational response to the economics essay question. This economics paper would easily achieve a grade A from an economics tutor during an examination. What else can you learn from this essay? 

Thank you for reading and cheers!