TMJC 2022 A Level H2 EQ1

2022 A Level H2 Economics Suggested Answers to Paper 2 EQ1 © TAMPINES MERIDIAN JUNIOR COLLEGE Essay Question 1: Economists usually begin their analysis of decision-making by firms by assuming that the objective of a firm is to maximise its profit. In reality, however , there are many different objectives that a firm might adopt. (a) Explain the likely effects on a firm’s price and output when its objective changes from profit maximisation to profit satisficing. (b) Discuss the most appropriate strategy that a firm could adopt if its objective was to reduce the competition that it faces. Suggested Answer: Part (a) Introduction: [Definition] Profits = Total revenue – total cost. All firms ultimately, or traditionally, aim to maximise profits. However, in reality, firms do not necessarily set price and output at profit -maximising levels and may set price and output at profit satisficing levels, due to lack of information or violati on of the ceteris paribus assumption, or unwanted attention from the government. Body/ Development: Topic sentence: For firms to maximise profit, they would produce and set prices where Marginal Cost is equivalent to Marginal Revenue ( MC=MR), and where MC cuts MR from below. Explain with economic analysis: MC is the change in total cost as a result of producing an additional unit of output. It shows the extra cost of producing an additional unit of output. On the other hand, MR is the additional revenue gained by selling one more unit of output. Assuming that the firm is a large, dominant firm, Figure 1 shows the profit-maximising price and output, ceteris paribus.

2022 A Level H2 Economics Suggested Answers to Paper 2 EQ1 © TAMPINES MERIDIAN JUNIOR COLLEGE If the firm produces OQa where MR > MC, then producing the last unit of output adds more to revenue than to cost. This implies that the firm should increase its output till Q1 where MR = MC. Hence the total profit of the firm could be increased by producing another unit of output. Conversely, if the firm produces OQb 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 till Q1 where MR = MC. Total profit could be increased if the last unit of output were not produced. Thus, profit (area P1ABC) is maximised when the firm produces OQ1 where MC = MR provided MC cuts MR from below. Topic sentence: The firm’s price may rise a nd output may fall when its objective changes from profit maximisation to profit satisficing. Explain with economic analysis: Rather than trying to maximise profits, firms may aim to profit satisfice where managers aim for a profit level that will keep shareholders happy. This may be because they are reluctant to accept the increased risks and pressures associated with fiercely competitive policies, or because they are seeking to satisfy not only shareholde rs but also other stakeholders such as workers, consumers, suppliers, the local community and environmentalists. These groups may have different objectives: consumers want low prices and high quality; workers want high wages, job satisfaction and security; suppliers want a high price; the local community want employment but an absence of congestion; and environmental groups want a clean environment and the conservation of flora and fauna. For example, r ather than trying to maximise profits, firms may aim to profit satisfice when managers prize a positive work environment and employer -employee relationships over profit-maximisation. In such a case, a manager, instead of sacking underperforming workers and go through the difficulty of firing workers in the process creating a bad feeling in the workplace, may continue to employ them. All these will subsequently raise the MC and AC for the firm. The firm will then produce at a higher price of P2 and a lower output of Q2 where MC = MR provided MC cuts MR from below as seen in Figure 2. It will also reduce profits in the short run from area P1ABC to area P2C2CD. Although profits are lower than what the firm could have earned if it had chosen to maximise profits, the strategy keeps employees happy and still makes enough profits to keep shareholders satisfied. The same analysis could apply to firms which choose more costly but environmentally friendly production methods in line with beliefs rooted in sustainable living and are quite satisfied with lower profits of P2C2CD which are sufficient to keep shareholders and stakeholders satisfied. An example would be H&M, which has pledged to become 100% climate positive by 2040 by using renewable energy and increa sing energy efficiency in all its operations, including making a commitment to make the first two tiers of its supply chain climate neutral by 2030. H&M has also pledged to use 100% recycled or sustainable materials by 2030, a pledge that is also evident in IKEA.

2022 A Level H2 Economics Suggested Answers to Paper 2 EQ1 © TAMPINES MERIDIAN JUNIOR COLLEGE Profit satisficing could also see a fall in price and rise in output compared to profit - maximising. This is particularly evident in sole proprietor mom-and-pop shops (usually small, independent and family-owned businesses). It is not uncommon for food hawkers to keep prices low despite hikes in production cost causing MC & AC to rise from AC1 & MC1 to AC2 & MC2 due to rising energy or ingredient prices. In this case price is kept at P1 instead of rising to P2 if the hawker had been profit -maximising and out put remains at Q1 instead of falling to Q2, causing lower profits of P1AXY instead of P2C2D – which keeps the hawker satisficed as his customers can continue enjoying his dishes at affordable prices. Another example is when, f or the benefit of society, a non-profit tuition agency hoping to reach out to and benefit as many underprivileged children as possible charges its tutees a price that is just enough to cover average cost of tutoring at PT where AR (=DD) = AC i.e., AC-pricing, choosing to earn normal profit at price PT & quantity QT rather than maximise profits at P1ABC by charging price P1 and providing Q1 amount of tuition services. Such pricing and output behaviour could also be applied to a firm seeking not so much social good, but longer-term market share dominance. Such a firm might conduct AC- pricing where AR = AC in the short run , setting a price and output level (PT and QT) that is respectively lower and higher than that which maximises profits (P1 and Q1) and be satisfied with lower or even normal profit in the short -run (as opposed to P1ABC1) in order to maximise sales/growth so as to monopolise the market, charge higher prices and earn larger profits in the long run. Figure 2 One example of profit satisficing that sees price higher and quantity lower than profit - max; and one where price is lower and quantity higher than profit-max. X Y PT QT

2022 A Level H2 Economics Suggested Answers to Paper 2 EQ1 © TAMPINES MERIDIAN JUNIOR COLLEGE Conclusion: Firms can also have other objectives such entry deterrence to prevent the entry of new firms or aim to increase market share and hence market power via predatory pricing to reduce the competition that it faces. Mark Scheme (a): Level Descriptors Marks L3 For a response which shows strong economic analysis to explain how firms determine price and output when maximising profits and the impact on price and output when there is change in the firm objectives changes from profit maximization to profit satisficing. 8-10 L2 For an under-developed explanation. Appropriate economic concepts and analysis is used but analysis lacking to address the change on the impact on price and output when there is change in the firm objectives changes from profit maximization to profit satisficing. 5-7 L1 For an answer that show