TMJC 2023 A Level H2 EQ3 AP Answers

2023 A Level H2 Economics (9570) Suggested Answers to Paper 2 EQ3 © TAMPINES MERIDIAN JUNIOR COLLEGE 1 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 consider s 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 lack of competition, discuss whether consumers will be disadvantaged and what might be the most appropriate form of government intervention. [15] Suggested answers to (a) Introduction There are various factors that would affect a firm’s decision about the price and output level of its product, and one of it would be the level of competition. This is because the differing levels of competition would affect the firm’s market power and thus , its ability to set prices above its marginal cost. Development Requirement 1: Explain how firms in industries with high levels of competition make decisions about the price and output level of its product both in the SR & LR (perfectly competitive markets) In markets with low/ no barriers to entry, firms will be faced with high levels of competition. An example would be the case of perfectly competitive markets such as agricultural products. In such cases, where there are many firms in the market, each firm holds on to insignificant amount of market share and thus market power. In this case, the firms are price takers, with no ability to influence the price. As such, the firm will charge the market price, which in turn is determined by the market demand and supply of the good. Thus, the firm faces a perfectly elastic demand curve , as seen in the diagram below. Figure 1: PC Industry and Firm

2023 A Level H2 Economics (9570) Suggested Answers to Paper 2 EQ3 © TAMPINES MERIDIAN JUNIOR COLLEGE 2 As seen above, the firm’s output will be determined by the profit maximising condition. Assuming the firm seeks to maximise profits, it will be producing at the output where MC=MR. If the firm produces at an output level where MR > MC, then producing the last unit of output adds more to revenue than to cost. i.e. total profit will increase. Hence, as long as MR exceeds MC, profits can be increased by increasing production. OR If the firm produces at an output level where MR < MC, then producing the last unit of output adds more to cost than to revenue. This implies that the firm should reduce its output to increase profits. The firm’s profits are maximised when the firm produces at an output level where MC = MR, and MC cuts MR from below. However, the perfectly competitive firm’s price and output would change in the long run. Assuming the firm is earning supernormal profits in the short run, this would attract new firms in the market. Since there is no BTE, firms can enter and exit the mark et easily. The entry of new firms in the market would increase market supply and thus lower market price. This in turn would lower the firm’s AR & MR curve. The shift in the firm’s demand’s curve would also lower the firm’s price and output level. Thus, the perfectly competitive firm will be charging a lower price and output in the long run. Requirement 2: Explain how firms in industries with low levels of competition make decisions about the price and output level of its product both in the SR & LR (imperfectly competitive markets) On the other hand, a firm facing low levels of competition due to strong barriers to entry would enjoy significant market share and thus market power. This is likely to be the case in imperfectly competitive markets such as the airline industry. The firm will have the ability to set prices and thus faces a downward sloping demand curve. If the airline firm wishes to sell more, he will have to lower the price; if he wishes to sell at a higher price, he must be prepared to sell less. The airline firm can thus determine the price or the output, but not both price and quantity. Moreover, the price elasticity of demand for the airline company is likely to be less than one given the lack of close substitutes available. Assuming that the aim of airline companies is also to maximise profits, the profit maximising price, Pm and output, Qm, will be determined where MC=MR as shown in the diagram below.

2023 A Level H2 Economics (9570) Suggested Answers to Paper 2 EQ3 © TAMPINES MERIDIAN JUNIOR COLLEGE 3 Figure 2: Firm in imperfectly competitive market In the long run, the imperfectly competitive firm will still be charging the same price and output despite making supernormal profits in the short run. This is because the presence of BTE prevents new firms from entering the market enabling the airline company to retain its supernormal profits earned. Conclusion The differing levels of competition would affect the firm’s market power and thus ability to set prices. Firms facing high levels of competition will have lesser market power and thus will be setting lower price and output as compared to firms facing low l evels of competition. In addition, the strong BTE that results in low levels of competition would also imply that the firm’s price and output remain unchanged in the long run. Mark Scheme Level Descriptors Marks L3 For a response which shows strong economic analysis and application in terms of how the differing levels of competition would affect the firm’s price and output decision. 8 – 10 L2 For an under -developed explanation. Appropriate economic concepts and analysis is used but application is lacking. 5 – 7 L1 For an undeveloped answer with a listing of points 1 – 4

2023 A Level H2 Economics (9570) Suggested Answers to Paper 2 EQ3 © TAMPINES MERIDIAN JUNIOR COLLEGE 4 Suggested ans (b) If markets fail due to lack of competition, discuss whether consumers will be disadvantaged and what might be the most appropriate form of government intervention. [15] Introduction The lack of competition would imply that the firm has significant market power. In such cases, markets would fail due to allocative inefficiency whereby the right amount of the right type of goods is not produced. In such cases, the government would intervene to improve society’s welfare. Development Requirement 1a: Explain how market s fail due to lack of competition and why consumers would be disadvantaged A profit-maximising imperfectly competitive firm will produce its output up to the level where MC=MR as explained in (a). As shown in the diagram in (a), the firm will be selling output Qm at price Pm. However, at this output level, price is greater than marginal cost (P>MC). Since consumers value the last unit of the good more than it costs the firm to produce, consumers are disadvantaged as they are paying higher prices, and would experience a fall in consumer surplus from CPPCD to CPMB. The good is under -produced and thus, increasing the output can increase the welfare of the consumers. The underproduction of the good has led to the loss in welfare for the society, where welfare loss is measured by the area BDA . There is allocative inefficiency. Society’s welfare is maximised at output QPC where P=MC. Possible EV: The extent of market failure would be dependent on the extent of abuse of market power by the firm. With greater market share and thus power, the firms have higher ability to set even higher prices. Alternative EV: [E/Opinion] However, consumers may not necessarily be disadvantaged when