RI T2W4 Price+Mechanism+and+its+Applications Mark+Schemes

Y5 H2 Economics 2024 T2W4 Class Test 1 – Price Mechamism and its Applications (Mark Schemes) © Raffles Institution 1 Essay (Tuesday Group) The airlines industry made a dramatic recovery in 2022 and 2023, bouncing back from record pandemic-era losses to near-2019 levels. Economy-class fares are up 21 per cent compared with 2019. At the same time, oil and fuel prices spiked when the Russia-Ukraine war began in 2022. (a) Explain possible reasons for the increase in price of air tickets. [10] (b) Discuss the likely effects of the rise in price of air tickets on the total revenue of the airlines market and a related market. [15] Part (a) Question requirements: need 2 factors ▪ Requirement 1: at least one demand factor ▪ Requirement 2: ▪ at least 1 supply factor – reference must be made to jet fuel price as one of the supply factors ▪ Combined Effect Possible Ideas: 1. Demand Factor ▪ ‘revenge’ travel after prolonged lockdown /and also to visit families, friends and relatives after relaxation of travel restrictions ▪ rise in income due to economic recovery after Covid-19 ▪ air travel as a luxury good (YED > 1) – as income rises, demand rises more than proportionate. ▪ With reference to Figure 1, the rise in demand causes the demand curve to shift from D1 to D2. The shortage at prevailing price P0 causes consumers to bid up prices. ▪ detailed explanation of adjustment process (adjustment process needs to be explained only once in detail) ▪ The final equilibrium price rises from P1 to P2. Price Quantity of air tickets D1 S1 Q1 P1 O Figure 1: Market for air tickets D2 Q2 P2 Shortage

Y5 H2 Economics 2024 T2W4 Class Test 1 – Price Mechamism and its Applications (Mark Schemes) © Raffles Institution 2 2. Supply Factor ▪ From preamble, price of jet fuel rose. As jet fuel is an important input for airlines, production cost increases significantly. At the prevailing price, firms are willing to produce less. Thus, supply falls and the supply curve shifts leftwards from S1 to S2 as shown in diagram below . This results in a shortage and analyse effect on prices that rise to P2. 3. Combined Effect Both a rise in demand and a rise in supply result in a net shortage and the effect on price is determinate. Prices rise from P1 to P2 as shown in Figure 3 below. Price Quantity of air tickets D1 S2 Q2 P2 O Figure 2: Market for air tickets S1 P1 Q1 Shortage Price Quantity of air tickets D1 S2 Q1 P1 O Figure 3: Market for air tickets D2 Q2 P2 S1

Y5 H2 Economics 2024 T2W4 Class Test 1 – Price Mechamism and its Applications (Mark Schemes) © Raffles Institution 3 Mark Scheme: Knowledge, Application, Understanding, Analysis L1 • Response hardly linked to economic analysis and is fraught with conceptual inconsistencies • Rambling without use of economic concepts and theoretical framework • Poor understanding of concepts of demand and supply and unclear link to determinants 1 – 4 L2 Credible attempt at economic analysis but with some errors in analysis • only 1 requirement analysed • examined only DD factors or only SS factors • factors stated but without elaboration • no reference to preamble on jet fuel prices • no reference to shortage nor surplus and adjustment process • limited depth of analysis • no reference to shortage nor surplus and adjustment process 5 - 7 L3 ▪ Both DD-SS factors well analysed ▪ Well-illustrated analysis /diagrams ▪ Adjustment process explained in detail 8 - 10 Part (b) Question requirements: ▪ Requirement 1 - Effect on airlines market ▪ Requirement 2 - Effect on related market Possible Ideas: 1. On Airlines’ Revenue Scenarios 1 or Scenario 2 deserve full credit while Scenario 3 deserves partial credit Scenario 1: If rise in price is due to a fall in supply, the effect on TR depends on PED for air travel. ▪ Demand for air travel is likely price- elastic since it takes a large % of consumers’’ budget ▪ Therefore a rise in price leads to a more than proportionate fall in quantity demanded ▪ Since TR=PXQ and the % rise in price < % fall in qty demanded, TR falls ▪ make reference to diagram that shows a leftward shift in supply curve with a relatively gentler demand curve. Ensure the area after the price increase has become smaller (e.g., TR increase due to price increase (= area B) is smaller than TR decrease due to the more than proportionate quantity decrease (= area A))

Y5 H2 Economics 2024 T2W4 Class Test 1 – Price Mechamism and its Applications (Mark Schemes) © Raffles Institution 4 Possible Evaluation for Scenario 1: [can be in Conclusion] The PED for different types of carriers may be different. ▪ demand for budget airlines or for short-haul flights/travel may be price-inelastic since it takes a smaller % of budget ▪ demand for business class can sometimes be argued to be price -inelastic as business travel may be paid for by the companies ▪ demand for domestic travel may be more price-elastic since there are substitutes such as trains and coaches ▪ any other sensible idea about differing PED Scenario 2: Combined Effect of a rise in demand and a fall in supply In part a, candidate should have analysed a rise in demand coupled with a fall in supply. The analysis continues here: ▪ Rise in demand leads to P rise and Q rise. ▪ Fall in supply leads to P rise and Q fall. ▪ Combined effect: Since both rise in DD and fall in SS have pushed prices upwards, this rise in price likely outweighs any change in quantity. Therefore, TR is likely to rise. ▪ Show simultaneous shifts in a diagram – illustrating clearly the effects of change in price vs qty and the resultant TR ▪ Answer can also weigh extent of rise in demand vs fall in supply with resultant impact on prices Scenario 3: (partial credit if this is the only scenario analysed) Due to a rise in demand, the final effect is an increase in equilibrium price and quantity. Thus TR rises. ▪ reference to diagram to show the change in area for TR Price Quantity of air tickets D1 S2 Q2 P2 O Market for air tickets S1 P1 Q1 Area B Area A Area C

Y5 H2 Economics 2024 T2W4 Class Test 1 – Price Mechamism and its Applications (Mark Schemes) © Raffles Institution 5 Scenario 3 is given partial credit as there is no reference to preamble about jet fuel prices which allows PED to be analysed nor reference to a combined effect which followed through from the analysis in part a Possible Evaluation for Scenario 3: [can be in Conclusion] There may be differing YED value for ▪ budget airlines vs main carriers ▪ economy class vs first class & business class 2. Related market ▪ can be substitutes or complements ▪ partial credit if answer linked to jet fuel since jet fuel is the cause of the fall in supply a. Substitutes such as travel by train A rise in air ticket prices causes a fall in quantity demand for air travel. For short distance travel or domestic travel, people increase their demand for train services. Make reference to diagram and illustrate a rise in TR (e.g., from area OP1AQ1 to area OP2BQ2) Possible Evaluation: [can be in Conclusion] ▪ CED value for train services: assess if strong or weak substitutes ▪ Likely substitutes for domestic travel and less likely for international travel ▪ In some cases, train tickets (bullet trains) may be more expensive than budget air tickets for the same destination ▪ A general increase in oil prices also affects production cost of train and coach services. So the degree of substitutability also hinges on the extent to which these different mode of travel increase their prices. ▪ Other factors that affect include duration, quality of train rides, convenience and waiting time. Price Quantity of train services D1 S1 Q1 P1 O Market for train serv