2023 HCI Prelim P1 Answers

© Hwa Chong Institution 2023 9570/01/A/C2 Prelim 2023 2023 H2 Econ Prelim P1 CSQ 1 Suggested Answers (a) (i) Explain why Boeing is concerned about the potential entry of Embraer and COMAC into the aircraft manufacturing industry. [3] The aircrafts manufactured by Embraer and COMAC are considered substitutes to the aircrafts manufactured by Boeing. [1] The demand for Boeing’s aircraft may fall thus the AR/MR shifts leftwards as airlines may decide to buy the aircrafts from Embraer and COMAC. [1] Assuming the average cost curve and marginal cost curve are unchanged, the market share of Boeing would fall, reducing the profit. [1] (ii) Use a diagram to explain how Boeing could use limit pricing as a strategy to discourage the potential entry of Embraer and COMAC. [3] Diagram [1] In the above diagram, Boeing may decide to sacrifice some short-run profit by pricing lower at P1 and producing higher at Q1, instead of the profit maximising price (Pe) and output (Qe). Since P1 is below the estimated average cost of the potential entrant firm (Embraer and COMAC), this would imply that if Embraer and COMAC enters the market and competes, it may incur significant losses. [1] Thus if Embraer and COMAC enter the market, it would make subnormal profit. If the firm is rational, it would not enter based solely on the profit consideration. [1] (b) Using a relevant example from Extract 1, explain how average fixed cost is affected as an aircraft manufacturing firm increases its output in the short run. [2] Examples of fixed costs are the costs incurred to build factories, assembly lines, hangars and testing facilities. [1] As the output increases, the fixed cost remain unchanged hence average fixed cost will fall. [1] (c) Explain how average total cost will change as an aircraft manufacturing firm expands its scale of production in the long run. [2] As the firm increases its scale of production in the long run, such as building more factories, assembly lines, hangars and testing facilities, these costs are spread over a larger unit of

© Hwa Chong Institution 2023 9570/01/A/C2 Prelim 2023 output. The unit cost of production woud fall due to internal economies of scale hence average total cost falls. [1] As the scale of production continues to rise and output is produced beyond the minimum efficient scale, internal diseconomies of scale would cause the average total cost to rise. [1] (d) (i) Explain what is meant by efficient allocation of resources in a free market. [2] In a free market, assuming there are no external costs to third parties and no external benefits to third parties[1], resources are allocated efficiently at the equilibrium output where MSB=MSC [1]. (ii) Discuss whether negative externality is the main reason for a government to restrict recreational use of cannabis. [8] R1: Negative exter