MI 2023 PU3 H2 Econs EOY P1 Suggested Ans

[Turn over Suggested Answers – CSQ1 (a) (i) Using Figure 1, compare the trend in the prices of medical care and all goods and services between 2000 and 2023. [2] The prices of medical care and all goods and services have increased between 2000 and 2023. The prices of medical care increased at a faster rate as compared to the prices of all goods and services. General trend – 1 m Refinement – 1 m Markers’ Comments The question is generally well-attempted. Students are reminded not to compare period by period. (ii) How will the rise in price of prescription drugs af fect consumer’s expenditure on healthcare? [2] The demand for prescription drugs is price inelastic as they are necessities to treat illnesses. [1] The rise in price will lead to a less than proporti onately fall in quantity demanded. Hence, consumer expenditure will rise. [1] Markers’ Comments Students who understood the requirement of question brought in the relevant elasticity concept and link to expenditure. Those who did not, simply said expenditure had increased as consumers are buying more drugs. S tudents must read the question carefully. The cause is stated in the question  rise in price. (b) With reference to Extract 2, explain how price controls can make prescription drugs more affordable and how it will impact consumer surplus. [4] The government can impose price ceiling on prescrip tion drugs to make it more affordable. It is set by below the market equilibrium price which is deemed too high. With price ceiling, the price will drop from Pe to Pmax. The consumer surplus has increased from PeYE to PmaxYXW.

2 MI/9757/01/PU3/EOY2022 [Turn over Explanation of measure [1] Impact on the price [1] Impact on consumer surplus [1] Diagram [1] Markers’ Comments Common mistakes made by students - Diagrams are not labelled properly - Consumer surplus after the imposition is identifi ed incorrectly (c) With reference to Extract 3, explain two types of barriers to entry that pharmaceutical firms possess. [4] The first will be legal restrictions due to the law. Patents are exclusive rights given to production for drugs for a number of years. With patents, other firms are not allowed to produce the drugs or they can be subject to court action. [2] The second type of barrier to entry will be high set up costs such as the costs involved in research and development of new drugs and the ma nufacturing facility ($1.2 billion). [2] Hence, these two BTEs will prevent new firms from entering the market. Markers’ Comments Most students did well for this question. Those who did not, only brought in one BTE or did not bring in evidence from the extracts. Stu dents are reminded to complete the analysis to explain how the BTEs will prevent new firms from entering the market. (d) Discuss whether product innovation is the most effective strategy for enhancing the profits of a pharmaceutical company. [8] From extract 3, the innovation gap, also called the innovation deficit, is happening as companies watch some of their bestselling products of the last decade approach the end of patent protection, revenues are bound to erode. This will affect the profits (Total revenue – total costs) of firms. Product innovation is an effective strategy to enha nce profits of a pharmaceutical company. Production innovation is needed to come up with better/new drugs. With successful innovation, the demand for the new drugs will rise and make it more price inelastic from D0 to D1.

3 MI/9757/01/PU3/EOY2022 [Turn over With reference to Figure above, at the original dem and D0, the profit maximisation price and output where MC = MR0 were P0 and Q0 respectively. At P0 and Q0, the supernormal profit was the small shaded area ((P0 – AC0) x Q0. With discovery of new drugs due to innovation, thee will be an increase in demand and reducing the PED, the demand curve shifts right and becomes more inelastic from D0 to D1. The profit maximisation price and output where MC = MR1 then becomes P1 and Q1 respectively. At P1 and Q1, the supernormal profit is now the larger shaded area ((P1 – AC1) x Q1. This increase in profit is mainly due to an increase in TR (from P0 x Q0 to P1 x Q1). Product innovation has caused an increase in price, output, and hence the TR and profit. Evaluate product innovation. Increase in profit does not take into account the cost of product innovation. R&D cost the firm money. If the increase in cost of producti on is more than the increase in revenue from the higher and more price inelastic demand, the firm’s profit would fall instead. Additionally, R&D takes a long time and may not always be successful. Other than product innovation, the pharmaceutical f irm can also look into process innovation (e.g more efficient method of production of drugs) to rise profits. This would reduce both the average cost of production an d the marginal cost of production.

4 MI/9757/01/PU3/EOY2022 [Turn over With reference to fig above, with the original MC0 and AC0, the profit maximisation price and output where MC0 = MR were P0 and Q0 respectively. At P0 and Q0, the supernormal profit was the small shaded area ((P0 – AC0) x Q0. With process innovation, the MC and AC decrease from MC0 and AC0 to MC1 and AC1. The profit maximisation price and output where MC1 = MR then b ecomes P1 and Q1 respectively. At P1 and Q1, the supernormal profit is now the larger shaded area ((P1 – AC1) x Q1. This increase in profit is mainly due to a fall in TC (from AC0 x Q0 to AC1 x Q1). We see that process innovation has ca used a decrease in price, an increase in output, and an increase in profit. Evaluate process innovation. There is cost involved in process innovation and this might eat into the profits of the firms. Evaluative conclusion From extract 3, patent expirations are expected to put $226 billion in global prescription sales at risk through 2026. Hence, product innovation is very significant in affecting the profits of the firms. Once new drugs have been discovered, firms will then need to work on process innovation to improve the efficiency of the production process to further increase profits. Hence, both product and process innovation are important in increasing firm’s profits. Knowledge, Application, Understanding and Analysis Mark L2 For a well-developed and balanced answer on whether innovation is the best strategy to increase profits. Consider both product and process innovation and the limitations. Clear and c oherent analysis, grounded by economic concepts, frameworks and principles and with application to the pharmaceutical company. Max 4 – Product and process innovations are well-explained but no limitation. 4-6 L1 Answer lacks balance or scope or reference to case material or details. 1-3 E Makes a substantiated judgement that answers the question. 1-2

5 MI/9757/01/PU3/EOY2022 [Turn over Markers’ Comments Many students explained how product innovation work to increase profits but some saw it as process innovation. Stronger students structured their answers in terms of strategies that led to revenue maximization (produc t innovation) and cost minimization (process innovation) thereby explaining profit maximising explicitly. However, quality of answers were uneven because of the quality of explanation and economic analysis given. Stronger students were clear in the diagrams and analysis but weaker ones cannot even get the diagram drawn correctly. Main mistakes include using collusion as a strategy when the question is about competition via product innovation. (e) Discuss whether government intervention is necessar y in cases where a pharmaceutical company holds a dominant position in