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Economics Model Essays

Market

Structures

Question 1

(a)

Explain how the different features of monopolistic competition and

oligopoly affect price and output determination in these market structures.

Intro

Both MC firms and oligopolies generally determine price and output

based on profit-max condition:

MR = MC

MC is rising

Due

to different features of MC firms and oligopolies like:

BTEs

Ability

to reap EOS

Mutual interdependency (in oligopolies only)

à MC firms and oligopolies set price

and output at different levels

P1: BTEs and ability to set high

prices

firm

Oligopolist

Diagram

Features

Low/non-existent BTEs

Sell

slightly differentiated products

Generally

small size

Low levels of market share

High

BTEs

Dominated by a few large firms

Example

Hawker stall

Low set-up cost (rental)

Low skill requirements

à Large no. of hawker stalls set up

à Each with small market share

Different hawker stalls produce food of different variety

Singtel

High set-up costs (laying cables)

à Few no. of telecomm firms

à Each with large market share

Homogeneous or differentiated product (e.g. SingTel, M1 and Starhub offer

telecommunication services which are homogeneous, but can bundle different phone plans to offer

to customers)

Low/non-existent BTEs + slightly differentiated products

à Smaller market

Lower and more price-elastic demand

Lower price of PMC

based on profit-max condition

High BTEs

à Enjoy more market power

Higher and more price-inelastic demand due to fewer competitors

à Steeper and

higher AR and MR curve

à Can set higher

prices

à Firm sets higher price of Po based on profit-max condition

P2: BTEs and EOS

While

oligopolist firm’s output is higher than MC firm’s output (QMC),

since oligopoly serves a larger portion

of the market

à Combined output in monopolistic competitive

market may > oligopolistic output

However

if oligopolist is able to earn EOS

(e.g. financial economies due to discounts on bulk purchases

à MC shift down

à Able

to match MC firm’s price of PMC

or even charge a lower price

à Output

will increase in the oligopolistic market

P3: BTEs and ability to retain

supernormal profits in the long run

firm

Oligopoly

Low/non-existent BTEs

à Free entry of competitors

à Erode away any supernormal

profit in the long run

à Normal profits only in the

long run

High BTEs

à Firm maximizes profits at MC = MR,

where MC is rising

à Equilibrium price PO and quantity QO

à Can retain supernormal profits in the long run (shaded area)

P3: Mutual interdependency

Mutual

interdependency

à Price rigidity

firm

Oligopoly

Lower extent of mutual interdependency

à No price rigidity

Possess significant market share

à Actions of one firm likely to affect other firms

à Assumption: Rival firms match price decreases but not price increases

Rise in price

Fall in price

More than proportionate decrease in no. of customers

Less that proportionate increase in no. of customers

à Low tendency

for oligopolies to deviate from market

price as this will result in a fall in revenue

(b)

Recession will affect firms in different ways depending, for

example, on what they produce and the market structure in which they operate.

Discuss the likely effects of a recession on different firms.

Intro

Define

recession: 2 consecutive quarters of negative

growth

à Rise in unemployment

à Fall in incomes

à Fall in consumers’ purchasing power

Impact

on firms depends on:

Normal

(Luxuries/necessities?)/inferior goods?

Market

structure

Whether

or not firms can accumulate supernormal

profits in past year

à Buffer during recessions

Adaptive strategies to cope with recession

P1: Producers of inferior goods will

benefit, producers of normal goods will suffer

Define

YED:

Measure

of responsiveness of demand to

changes in income, ceteris paribus

Positive for normal good and negative for inferior good

During

recession

Producers of normal

goods

Producers of inferior

goods (Hawker food)

Fall in demand

Inward shift of AR and MR curves

Assume unchanged MC curve, eqm price and quantity

falls

Total revenue earned falls

Subnormal profits

Fall in purchasing power during recession

à Incentivize consumers to switch to inferior goods (relatively cheaper)

Rise in demand

à Rise in eqm price and quantity

Total revenue earned increases

Supernormal profits

Necessities

(rice)

Luxuries (LV bags)

Income-inelastic

Fall in income results in less than proportionate fall in demand

Producers

of necessities will not earn a lot

less/incurred loss may be lower

Income-elastic

Fall in income results in more than proportionate fall in demand

Because

luxury goods consumed only after

expenditure on necessities has been accounted for

Producers

of luxury goods likely to experience a larger

drop in revenue during

recession

T1: Oligopolies may not suffer greatly

due to BTEs

Firms

that can accumulate supernormal profits

(e.g. oligopolies and monopolies) can use these reserves to cushion fall in revenue during

recessions

BTEs high enough to prevent entrants

à Allowing

existing firms to earn supernormal profits in the long

run

à Excess profits from previous years act

as buffer

à Firm may not go into financial distress during recession

à Less likely to close down compared to

MC firms

Can

invest excess funds into product differentiation or advertisements

à Retain existing customers and reduce extent of fall in demand

May

consider mergers

à Increase resiliency during recessions

Dominant firms with excess reserves may also take

the chance to acquire other weaker

rivals at a bargain price

à Boost

market share

AT1: Oligopolies may suffer more

compared to natural monopolies due to nature of good (luxury vs necessity)

Luxury goods such as branded bags usually produced

by oligopolies while necessities like water are produced by

a natural monopoly like SG’s PUB

Because

sale of branded bags usually requires extensive

marketing budget, which are available to oligopolistic firms that can accumulate

supernormal profits in the long run

High BTEs (brand

loyalty)

à Prevents entry of new competitors

Product promotion and development

à Branded

bags are differentiated

Natural

monopolies usually responsible for production of public utilities given

High set-up costs

Extensive EOS that can be earned from large-scale production

Hence

while both firms have supernormal

profits to act as a cushion, producers of branded goods (usually oligopolies)

may experience a bigger drop in demand

as demand for luxury goods is more income-elastic.

PUB may not experience a significant drop in revenue given the income-inelastic nature of water (necessity)

firms may experience a rise in demand if they sell inferior goods

AT2: MC firms may suffer less compared

to oligopolies due to flexibility in operations

MC firms have lower sunk costs

Able to change mode of operation more easily

than oligopoly

E.g. hawker stall can change menu by introducing more economical lunches (inferior goods) to

cater to consumers whose income had fallen during recession

à May

be more flexible in their operations

à Increases MC firms’ likelihood of surviving recession

Less

straightforward for oligopoly like Tony

Romas steakhouse to change menu as this is not in line with firm’s corporate branding

Conclusion

Recession

can affect firms differently depending on:

Type of goods sold

Market structure in which the firms operate

Firms

selling inferior goods generally benefit

while producers of normal goods are

affected to different extents, depending on whether they sell luxury goods or necessities

Market

Structures

Question 2

Retailers

in Singapore supply a wide range of services and products in a variety of

market structures

(a)

Consider different retailers in Singapore and discuss which market

structure, oligopoly or monopolistic competition, best explains their market

behavior.

Intro:

Market

Structures

Question 3

very popular band is due to play one concert at a 5000 capacity venue. The plan

is to charge different prices according to the area in which the seat is

located.

(a)

Explain whether this pricing policy could be considered to be an

example of price discrimination.

Intro

Define

price discrimination:

Practice of charging different prices for different units of the same good, where such differences are not due to cost considerations

types:

1st degree: Price charge to each customer

is maximum they are willing to pay

2nd degree: Discounts for bulk purchase

3rd degree: Prices differ across markets

with different price elasticities of

demand

Event

organizer’s pricing policy resembles 3rd

degree price discrimination, assuming:

Seats

are identical

No difference in cost of providing each seat

T: Yes, this is price discrimination

because different prices are being charged for different units of the same good

and this is not due to difference in cost of production

Fulfills definition:

✔ Different prices

are being charged for different units of the same good (ticket)

+ no difference in cost of

providing each concert seat

Modern

concert halls have good sound systems

à Assume

quality of enjoyment derived by concert

goers does not vary according to the position of their seat

à Hence

quality of each unit of good assumed

to be similar

Most of sunk costs are invested into logistical

and performance fees

à Cost of providing each seat/ticket

should not vary

à Different prices also unlikely to arise from cost considerations

Conditions

of 3rd degree price

discrimination fulfilled

Firm

possesses monopoly power

Existence

of high BTEs

High

set-up costs,

Exclusive

tie-up arrangements with the performing band,

Logistic

arrangements for large-scale events, rental of venue

Firm

possesses ability to segment market based

on different price elasticities

Define

PED: Degree of responsiveness of

quantity demanded when price changes.

>1 for price-elastic demand,

for price-inelastic demand.

Customers in front row seats are usually die-hard fans

Other shows cannot substitute

à Relatively price-inelastic demand

à Charging higher prices in the market with price-inelastic demand results

in increase in revenue

Consumers who choose seats further away from stage may be indifferent towards viewing performers

up-close

à Relatively price-elastic demand

à Charging lower prices in the market with price-elastic demand results in

an increase in revenue.

Resale of goods not possible

Most

concert tickets are printed with buyer’s

name

Prices tied to seat location

à No

incentive for customers with

price-inelastic demand (die-hard fans) to buy cheaper tickets from

consumers with price-elastic demand since these tickets are usually for back-row seats

AT: No, this is not price

discrimination as cost of production or product quality may be different

Cost of offering a front-row seat may vary: armchair seats and refreshments are provided in these

sections (e.g. VIP sections)?

Nature of satisfaction which audience derives could vary

depending on how far they are seated from the stage: band is popular for its visual performance,

e.g. dance?

(b)

Discuss the problems that are likely to be faced in determining

the prices to be charged for the seats.

Intro

determine price for concert tickets, firms generally consider profit-max condition

MR = MC

MC rising

Difficulty

in measuring

Implicit costs

Demand for its product

Difficult to measure MR

Price-elasticity of demand for product

Difficult to practice price discrimination

Event

organizer may operate in an oligopolistic

environment

à Experience

price-rigidity

à Must be mindful of setting prices that are not in line with those of their competitors as this could result in the firm losing a disproportionate no. of customers

P1: Difficulty in estimating the

opportunity cost of organizing the event

Total Cost

Explicit

Implicit

Fixed

Variable

Opportunity cost

Incurred

regardless of the final turnout

Cost

of booking the venue

Bands

performance fees

Low

since they largely include cost of printing

tickets which is relatively cheap

à MC negligible

Profits are maximized where

MR = MC = 0

potential returns if

funds and resources are invested into the performance are invested into

organizing other events instead

this case, firm may be more concerned

with selling off tickets to 5000 people rather than setting a price which allows it to maximize profits

P2: Difficulty in estimating demand

Demand

affected by population’s taste and

preferences

Even harder if this is first time that band is performing in the country (no past ticket

sales to reference from)

Firm

needs to

Find

information from band’s fan base or

album sales

Derive price consumers are willing to pay from demand curve

Conduct

publicity efforts

à Increase

awareness of event to maximize ticket sales

Investigate

consumer’s income

à Make tickets affordable

P3: Difficulty in estimating PED for

concert ticket à

difficult to practice price discrimination

PED

affected by

Proportion

of income consumers spend on the ticket

Degree

of necessity of ticket to consumer

ticket sales are usually done online

à Difficult

for the firm to assess consumer’s income and degree of necessity of the ticket

Some

older consumers may prefer to sit at the front due to their inability to climb

steps to access other seats

à Charging higher prices for front row

seats may price these consumers out of the market

P4: Firm may encounter price rigidity

so loss in revenue can happen easily

High barriers

to entry exist in the event organizing industry à oligopolistic à mutual interdependency as each event

organizer possesses significant market share à actions of one firm likely to affect

other firms (e.g. if one firm prices tickets cheaply

Market

Structures

Question 4

(a)

Explain how, in economic theory, a monopolist would determine

the price that would maximize profits.

(b)

Discuss whether firms in the real world set prices at

profit-maximizing levels.

Market

Structures

Question 5

(a)

Using appropriate examples, explain the difference between

internal and external economies of scale.

(b)

Discuss the view that the profit motive will always lead to a

few large firms dominating the market for each and every type of product.

Market

Failure and Government Intervention

Question 1

(a)

Explain how, according to economists, the pursuit of self-interest

can help to address the problem of limited resources and unlimited wants.

(b)

Assess whether the price mechanism will always allocate scarce

resources in the most efficient manner for all goods and services in a market

economy.

Market

Failure and Government Intervention

Question 2

(a)

Explain why government intervention is advocated in the markets

both for public goods and for goods where externalities are present.

(b)

In the UK, entry to national museums and art galleries is free

of charge and tickets to see the opera are heavily subsidized. In contrast, in

Japan, entry to museums and art galleries comes at a high price and a ticket to

see an opera is among the most expensive in the world. Assess the economic case

for these 2 different approaches.

Market

Failure and Government Intervention

Question 3

Governments

around the world protect consumers against market failure due to market

dominance.

(a)

Analyze, with supporting examples, how market dominance might

lead to market failure.

(b)

Assess the extent to which market dominance, rather than any

other potential market failure, is the major cause of government intervention

in the markets for goods and services within Singapore.

Market

Failure and Government Intervention

Question 4

(a)

Explain why imperfect information and immobility of factors of

production may lead to market failure.

(b)

Evaluate policies currently used by the Singapore government to

correct these causes of market failure.

Market

Failure and Government Intervention

Question 5

With

reference to examples, discuss whether there is a need to change the current

policies adopted by the Singapore government to deal with market failure caused

by externalities.

Market

Failure and Government Intervention

Question 6

Discuss,

with economic reasons to support your arguments, whether the Singapore

government currently adopts the most appropriate economic policies in the

provision of education.

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