EJC Econs N2023 H2 EQ3 - students

Suggested answer for 2023 A-Level Paper 2 Question 3 A firm’s decisions and strategies are influenced by the level of competition in the industry. Its decisions and strategies might also be affected by consumers’ cognitive biases and concerns about the environment. (a) Explain why a firm considers the level of competition in the industry when making decisions about the price and output level of its product. [10] (b) If markets fail due to a lack of competition, discuss whether consumers will be disadvantaged and what might be the most appropriate form of government intervention. [15] Part (a) - Question Analysis Approach Command Word Explain Question Type Cause and effect Start point Level of competition End Point Price and output decisions Content and Context Content • Level of competition  market structure  perfect competition, monopolistic competition, oligopoly, monopoly • Price and output decision  marginalist principle Context None Introduction State essay approach: A firm will aim to maximize profits when making decisions using the marginalist principle, producing at the output where marginal revenue (MR) equals marginal costs (MC). The level of competition determines the market structure the firm is in and the amount of market power it has. The market structure also affect whether a firm needs to consider the impact of rival’s reaction when deciding its pricing and output decision. Point 1: How high degree of competition affect pricing and output decision • A perfectly competitive (PC) firm faces high degree of competition as there are many small firms selling homogeneous products in the market due to the lack of barriers to entry. • As such, a PC firm has no market power and is a price taker due to its small market share. It follows the market price, P which is determined by the market demand and supply and faces a perfectly price elastic demand curve as shown in figure 1. Any attempt to increase price will result in quantity demanded falling to zero as consumers will switch to the many substitutes available. The firm has also no incentive to lower price as it can sell as much as it wants at the existing price. • At P, the PC firm will produce at Qfirm where MR = MC to maximise its profits. o If the firm were to produce Q1 unit, the MR (the extra revenue from selling one more unit) is greater than the MC (the extra cost of producing that additional unit). Producing this additional unit will benefit the firm as the extra unit will add to its total profits. o By producing an output greater than Qe output level (e.g., Q2,), the MC (the extra cost of producing one more unit) is greater than the MR (the extra revenue from selling that

additional unit. Hence, doing so will not