RI 2022 H2 Y5 Promotion Examination - Examiner's Report

ECONOMICS Higher 2 Syllabus 9570 Examiner’s Report Year 5 Promotion Examination 2022 R a f f l e sI n s t i t u t i o n N u r t u r i n g t h e T h i n k e r , L e a d e r & P i o n e e r TEL: 65 6419 9888 ● FAX: 65 6419 9898 http://www.ri.edu.sg ● One Raffles Institution Lane, SINGAPORE 575954

Y5/9570/Promo/2022 2 © RI 2022 [Turn Over ECONOMICS Y5 H2 Promotion Examination 2022 Paper 9570/01 Paper 1 Case Study (a) With reference to Figure 1, (i) describe the trend in the revenue of the US pharmaceutical industry from 2014 to 2019. [2] - General trend: There has been an increase in the total revenue for the US pharmaceutical industry over the whole period. - Refinement: The sharpest increase occurred between 2017 to 2018. Mark Scheme: - 1m for overall trend - 1m for refinement Examiners’ Comments: • This question was generally well done but some students failed to surface the most significant refinement, or used the wrong time period. Please be mindful of the period given in the question and that given in the data. (ii) explain one possible reason why the decrease in revenue of the US pharmaceutical industry is expected to continue beyond 2020. [2] Students are expected to explain any plausible reason with links to change in price, quantity, and hence revenue. Explain one demand factor: • Fall in demand as population is getting healthier • Fall in income due to recession caused by Covid-19 • The fall in demand leads to a fall in both P & Q and hence TR. OR Explain one supply factor: • An increase in supply of generic drugs due to the expiry of patents, and given that demand for drugs is price inelastic due to a high habituality of consumption, the fall in price only leads to a less than proportionate increase in quantity demanded and hence a fall in TR. Mark Scheme: - 1 m for reason explained - 1 m for link to effect on TR with an explicit link to P and Q

Y5/9570/Promo/2022 3 © RI 2022 [Turn Over Examiners’ Comments: • A significant number of students lost marks because there was no explicit link to P and Q in explaining total revenue change. • Those who identified price fall (due to increase in supply, or due to government regulation) did not use PED to link to total revenue. • Many said increase in R&D spending reduced revenue, suggesting a confusion over revenue and profits (b) With the aid of a diagram, explain whether an increase in a firm’s research and development spending will always increase its profits. [5] Short-run In the short-run, an increase in a firm’s research and development spending represents an increase in the firm’s fixed costs, since such spending does not vary with the current level of output produced by the firm. Hence there will be a rise in AC from AC0 to AC1, without any change in the profit-maximising output of Q0. Firm’s profits have fallen from (P0 – C0) x Q0 to (P0 – C1) x Q0 in the short-run. Long-run When a firm’s R&D spending is successful, it results in the creation of new drugs such as Daraprim and Sovaldi that cater to the needs of consumers more, increasi ng its demand from AR 1 to AR2. Furthermore, demand for the firm becomes more price inelastic as there are fewer substitutes to the new drug which may treat new illnesses or be more effective. Hence the firm’s price -setting ability will increase, leading to a higher price of P2 being charged at the higher profit-maximising output of Q2. The rise in demand causes a rise in PXQ causing TR to rise. Firm’s profits have increased from (P 1-C1) x Q1 to (P2-C2) x Q 2, assuming that the R&D efforts have been successful.

Y5/9570/Promo/2022 4 © RI 2022 [Turn Over Conclusion The impact of R&D spending will definitely result in a fall in firm’s profits in the short -run, but the long-run impact is uncertain. Profits will increase if the increase in TR outweighs the increase in costs, but the outcome of R&D is uncertain. Such uncertainty is supported by Table 1 - while Pfizer’s huge spending seems to yield a direct relationship with its TR ceteris paribus, that of Merck’s (the 3rd largest spender) seems to point otherwise. Furthermore, the outcome of R&D is u ncertain and may not lead to new medicines being developed – thus no effect on TR. Combined diagram: Mark Scheme: - 2m for explaining increase in TR with reference to case material - 1m for diagram - 1m for explaining R&D increases fixed costs - 1m summative statement on final effect, e.g. effect is uncertain - No reference to case material – max 4 Examiners’ comments: • Many did not make reference case material at all, some even discussed product differentiation with respect to iPhones!

Y5/9570/Promo/2022 5 © RI 2022 [Turn Over • R&D is a fixed cost and does not shift MC curve, while process innovation would change a firm's variable cost of production, shifting both MC and AC curves. • Poor diagram conventions, e.g. lack of labelling of axes, curves; failed to indicate profits accurately • Many did not explain potential revenue increase from product innovation, which is the more prominent form of R&D in pharmaceutical industry. • Some did not have balanced explanations for "explain whether", and many fell short of making a final conclusion. • Many incorrectly used market analysis to explain a firm's profit changes. • Some did not analyse the immediate impact of rise in R&D spending on profits and went off tangent (e.g. explaining how patents granted to new medicines may increase profits) • Some mistook total revenue for profits. (c) Wealthier countries pay “about the cost of a takeaway meal for each dose,” while middle - income countries pay roughly half that price’. Explain why this is a form of price discrimination. [3] • Define price discrimination: Firm selling of the same good to different consumers at different prices for reasons not associated with differences in cost of production. • Pharmaceutical firms are able to segment markets by different geographical locations with differing PED. • Drugs take up a lower proportion of income for wealthier countries, making demand relatively more price inelastic, hence a higher price is charged. • On the other hand, for middle-income countries where drugs take up a higher proportion of income, hence a lower price is charged. Mark Scheme: - 1m for recognizing price discrimination is due to difference prices for reasons not associated with cost differences - 2m for explaining why different countries are charged different prices due to differences in PED, with explicit link to the relevant PED determinant Examiners’ comments: - Many did not state PED determinant explicitly when explaining differences in PED - Many showed a weak understanding of price discrimination with irrelevant concepts explained, e.g. explanation of how PD achieves equity - Many missed out the "no cost difference" element of PD. - Some answers addressed "explain why firms can price discriminate", rather than "explain why this is an example of PD" - Many had imprecise descriptions of PED (e.g. vaccines are price elastic, price is elastic for vaccines, the demand is elastic, etc., all of which are inaccurate) (d) To what extent is government intervention necessary in research and development in the pharmaceutical industry/. [8] Introduction • Government intervention is necessary to correct market failure arising from positive externalities in production of R&D to achieve allocative efficiency.

Y5/9570/Promo/2022 6 © RI 2022 [Turn Over Thesis: government intervention is necessary in the market for R&D • From Extract 3, ‘R&D entails significant externalities that are difficult to capture by the private innovator’ in the pharmaceutical industry. • H