ACJC Market Structure Tutorial Answers

1 ©ACJC Econs Dept/2020/Firms and Decisions Tutorial Worksheet - Answers Section :C Case Studies Questions Question 4: Singapore’s big telcos face rising competition Questions: (a) Comment if Figure 2 supports the data shown in Figure 1. [3] Suggested Response: There is a positive relationship between the mobile penetration rate and Singtel’s operating revenue because when more people sign up for mobile plans, Singtel will be selling more units of mobile plans, leading to higher revenue. Hence, Figure 2 supports the data shown in Figure 1 from 2009 to 2012 as both show an increasing trend. However, from 2013 to 2014, Figure 2 does not support Figure 1 because Singtel’s operating revenue decreased when the mobile penetration rate increased. The inverse relationship between Singtel’s operating revenue and mobile penetration rate could possibly be due to new and existing users of mobile services preferring to patronise new telcos. Note: It is also acceptable for candidates to assert that that Figure 2 generally supports the data shown in Figure 1 for time period 2009 to 2018. Mark Scheme: 1m: Giving evidence for support for time period 2009 to 2012 1m: Giving evidence for did not support for time period 2013 to 2014 1m: Provide explanation for one of the above cases (b) (i) Explain the barriers to entry a new entrant like TPG would face in the mobile network market. [4] Suggested Response: Legal BTE: One of the barriers to entry faced by a new entrant like TPG would be legal barriers. As suggested in Extract 1, there are licensing and regulatory requirements that TPG would have to meet before they are able to operate in Singapore. Financial BTE: Another type of BTE faced by TPG would be financial barriers. As mentioned in Extract 1, TPG intends to get the funding it requires to operate its business in Singapore. As such, the entry of TPG into the Singapore market is contingent on its ability to raise funds from investors to finance its capital outlay. Note: It is also acceptable for candidates to assert that there are contrived barriers to entry. Candidates who associate telcos’ strategy of cutting prices of data plans as a contrived barrier must explain the following. Incumbent telcos respond to the entry of new telcos by adopting

2 ©ACJC Econs Dept/2020/Firms and Decisions Tutorial Worksheet - Answers predatory pricing such that it forces the new entrants – when compete on the basis of price - to operate at a loss. Mark Scheme: 2m: Identify + explain each type of BTE (b) (ii) Consider why it might be a rational decision for a new firm like TPG to enter the mobile network market. [3] Suggested Response: The costs to the firm would be the cost of setting up its infrastructure in a way that satisfies the licensing and regulatory requirements. The benefit to the firm is the revenue it would earn when selling its mobile plans to consumers. While the initial costs of starting up as a new firm is very high, the potential revenue it might gain upon successful penetration of the market is possibly higher. In Extract 1, it is mentioned that there is still room for competition and innovation in the market to cater to consumers. Furthermore, TPG intends to first target the senior citizens by tailoring its plans for them. The above implies that the market is large enough for a new entrant like TPG to still benefit. Therefore, since the potential revenue is likely to o utweigh the costs, it would be a rational decision to enter the market. Mark Scheme: 1m: Examples of costs 1m: Examples of benefits 1m: Evidence/justification of why it is rational to enter the mobile network market, i.e. benefits outweigh costs

3 ©ACJC Econs Dept/2020/Firms and Decisions Tutorial Worksheet - Answers (c) With the aid of a diagram, explain how a firm might determine its price and output. [4] Suggested Response: The objective of a firm is to maximise profits. To do so, the firm would produce an output level of Qπmax where MC = MR. The price will be determined by the AR curve at that given output level of Qπmax because AR curve represents all points which consumers are willing and able to pay. Thus, the price is set at Pπmax. MC = MR is the profit maximising condition because when output is smaller than Q πmax, the marginal revenue is larger than the marginal cost, hence it is beneficial for the firm to continue raising its production to gain profits. The firm will stop raising production when marginal cost is equals to the marginal revenue, giving rise to the maximum profit level. OR If the firm produces at any output that is higher than that at MC = MR, its marginal cost is greater than the marginal revenue, leading to a net loss. Therefore, the f irm can reduce its losses if output is decreased to Qπmax. Mark Scheme: 1m: Diagram (should include AC curve for completeness) 1m: Output determined by MC = MR condition 1m: Justify why MC = MR is the profit max condition by citing the case of either M C > MR or MR < MC 1m: Price determined by AR curve

4 ©ACJC Econs Dept/2020/Firms and Decisions Tutorial Worksheet - Answers (d) Comment on the likely impact on the profitability of incumbent firms like SingTel, following the entry of competitors into the telco market. [6] Suggested Response: Profitability is measured by revenue gains versus costs incurred. The impact on Singtel’s profitability following the entry of competitors depends on the strategies adopted by Singtel and its competitors. It is possible for Singtel’s profit to be eroded away such that either P = AC or P < AC where the firm earns normal and subnormal profit respectively. However, it is also possible for Singtel, given that it operates in an oligopoly, to continue earning supernormal profit where P > AC. Negative impact of increased competition on profitability: Singtel’s supernormal profit would be eroded by the entry of TPG should existing Singtel consumers be enticed by TPG’s offer of unlimited data for a period of a year. The switching of consumers to a rival telco would result in a drop in demand as fewer consumers would be willing and able to purchase the services provided by Singtel. Moreover, with more firms and different types of services available, Singtel’s product will be more substitutable, making the demand for their services more price elastic than before. Consequently, both equilibrium price and output determined by profit maximising condition of MC = MR . Profits would decrease as total revenue falls, ceteris paribus. Depending on the extent to which price fall, Singtel may earn a smaller supernormal profit, normal profit, or subnormal profit. Evaluation: How the impact of profitability may not be significant: In light of falling demand, Singtel can adopt cost -cutting strategies to lower its total cost in an effort to maintain or improve profitability. Cost -cutting strategies include automating business processes such that it reduces the need for labor. Such strategies would reduce total costs if assuming that automation is less costly than labor. Singtel’s profitability could improve If the fall in total costs outweighs the fall in total revenue due to the abovementioned reasons. OR Singtel may have established themselves as a reliable service provider. Moreover, consumers might continue to have strong preference for Singtel because of the customized plans, big discounts and product bundling (mobile, TV, internet) that it has to offer. Unless the new firms are aggressive in differentiating themselves, the impact on Singtel’s profits might be minimal. 2m for how demand and PED for Singtel’s services are affected 2m for linking to how profit is affected 2m for evaluation (any relevant comment that casts doubt on the view expressed)

5 ©ACJC Econs Dept/2020/Firms and Decisions Tutorial Worksheet - Answers (e) Assess whether incre