RI Y5 Promo Distinction Scripts 2021

ECONOMICS Higher 2 Syllabus 9757 DISTINCTION SCRIPTS YEAR 5 PROMOTIONAL EXAMINATIONS TEL: 65 6419 9888 ● FAX: 65 6419 9898 http://www.ri.edu.sg ● One Raffles Institution Lane, SINGAPORE 575954 Raffles Institution Nurturing the Thinker, Leader & Pioneer

ECONOMICS Case Study: (c) Discuss the impact the COVID -19 pandemic has on the profits of an ecommerce company in the US. [8] The Covid-19 pandemic has led to an increase in demand for ecommerce sales. This has an impact on the profits of an ecommerce company in the US, where profit is total revenue (TR) – total cost (TC). The company is assumed to want to maximise profits. The pandemic has led to the temporary closure of many physical stores and restrictions on movement (Ext. 1), which results in more consumers having to shop online for the goods. Since shopping online also reduces the risk of infection in public areas, the taste and preferences of the consumers may shift towards ecommerce (Ext. 1), resulting in greater willingness and ability to purchase online goods and a higher demand. Since there are less alternatives due to physical shops being closed, the reduced number of physical stores results in the demand for goods online being more price inelastic. This leads to a shift in the demand curve from AR0 to AR1, (and shift in MR from MR0 to MR1), ceteris paribus. Holding cost curves constant, the increase in demand results in a new profit maximising output level Q1 where MC = MR1, up from Q0. At this new equilibrium, price increased from P0 to P1, while average cost falls from C0 to C1. Assuming the firms has been making normal profits before, it now has supernormal profits of area P1abC1. This results in greater profits from the firm, ceteris paribus. However, costs for the company may also increase due to labour costs. Given that many ecommerce companies, including Amazon and Walmart are hiring over 150,000 workers each (Ext. 2), this leads to an increase in demand for labour. Assuming labour supply remains constant, there is a large shortage that pushes wages up significantly (to incentivise more workers to work). This leads to an increase in workers’ wages, which could have an impact on the TC for the firm since they may also need to hire more workers to cope with the additional demand for their goods. Given wage rate of workers is a variable cost, since the firm has to pay more wage costs if workers work longer hours or if it hires more workers (to increase outputs of online sales), this leads to an upward shift of the MC and AC curve to MC1 and AC1, respectively.

Holding demand constant, when MC increases, there is a new profit maximising output level that decreased to Q1. Price increases from P0 to P1 and average cost also increases from C0 to C1. If the firm used to make supernormal profit of area P0abC0, it now makes normal profits, hence there is a fall in profits, ceteris paribus. Overall, it may be more likely that the rise in revenue outweighs the rise in costs since the rise in labour demand may be offset by a similar rise in supply, since more workers are getting retrenched during the pandemic. Workers who previously worked at physical retail stores that have shut down may move to online retail, hence the increase in TC for an ecommerce firm may not be that significant. However, the increase in demand may also not be as significant (for a firm) as projected as there are additional companies entering the market such as Walmart (Ext. 2) which may offer substitutes for existing ecommerce platforms, making demand lower and more price elastic for incumbent firms, thus leading to fall in profits, ceteris paribus. On the whole, it is still likely that profits will increase, though to a smaller extent, due to the great increase in demand for ecommerce. This profit is likely to be sustained since the accelerated trend seen is projected to continue even after the pandemic (Ext. 1). Written by Sasha Poh (22S03H) (e) (i) With reference to Extract 4, explain why, in the absence of government intervention, resources may not be efficiently allocated in the market for ecommerce. [4] There are negative externalities of consumption present, leading to market failure where the market fails to allocate resources efficiently to maximise soc ial welfare and achieve social outcomes like equity. Negative consumption externalities occur when there are external costs on third parties due to the consumption of a good or service. This is evident from how self-interested consumers consider their own private benefits where they make many purchases online to increase their own utility and satisfy their needs and wants, like clothes they want to wear or food they need to eat. They also consider their own private costs like the costs of buying the good off online stores. However, they ignore the external costs imposed on third parties; for example, excessive packaging leads to immense plastic pollution. If such plastic is thrown (by the consumers) in the sea and consumed to the fish, human could end up consuming the microplastic instead, leading to negative health impact (on the general public). Therefore, there is a divergence between the marginal social benefit (MSB) and marginal private benefit (MPB) where MSB is lower than MPB. Assuming no production externalities, MSC = MPC. If left to the free market forces, consumers will consume at Qe where MPC = MPB. However, socially optimal level occurs at Qs where MSB = MSC. There is an overconsumption of ecommerce goods by QeQs units, meaning an overallocation of resources to the production and consumption of ecommerce goods. This leads to market failure and there is a deadweight loss of area ABC representing loss of societal welfare or the social benefits derived from consuming QeQs units is less than costs of

producing QeQs quantity of goods to the society. Therefore, resources are not allocated efficiently as social welfare is not maximised. eii) Evaluate the policies a government can implement in view of the above source of market failure in the ecommerce market. The government can consider implementing a tax. Imposition of a (per unit) indirect taxation on ecommerce retailers equal to the marginal external costs (MEB) (AD) at socially optimal output level Qs leads to a rise in the costs of production, leading to an upward shift in the supply curve from MPC to MPC + indirect tax. There is therefore a decrease in quantity supplied at every price level, ceteris paribus. This also translated into a rise in price for consumers of ecommerce goods, who are now disincentivised and reduce their quantity of ecommerce goods demanded. There is therefore a reduction in quantity consumed from Qe to Qs (where MPB = MPC + indirect tax). At Qs, efficient allocation of resources is achieved as deadweight loss of area ABC is eliminated. A tax would lead to an immediate reduction in ecommerce purchases and therefore lead to an immediate reduction in pollution generated, thereby solving market failure, as producers of ecommerce goods are forced to internalise the externality. However, given the pandemic, consumers may now have a very price inelastic demand for ecommerce goods due to high habituality of consumption because of the convenience. Therefore, there is a less than proportionate decrease in quantity demanded with a rise in price. A very high tax must be implemented to reach the socially optimal level, but such a high tax is inequitable and unpopular. Government can also consider educational campaigns. By increasing consumers’ awareness of the high environmental impact of pollution from large number of ecommerce purchases and the damage

5 caused to others, consumers are more willing to reduce their consumption of the ecommerce goods. There is thus a decrease in consumers’ demand from DD0 to DD1. Therefore