2024 TYS H2 Economics Paper 2 Essays Answers (HCI)

Suggested Answers to A Level 2024 H2 Economics (ESSAYS) by Hwa Chong Institution Economics Unit Question 1 AIn 2021, there were over 800 mergers and acquisitions in Singapore. This was a significant increase from just over 480 recorded in 2020. A justification for these mergers is that they allow firms to benefit fro m economies of scale. (a) Explain internal economies of scale and external economies of scale and their link to a firm’s long-run average cost of production. [10] (b) Discuss whether gaining economies of scale is the only justification for mergers and acquisitions. [15] Part (a) Introduction The long-run is a production period which all factors of production are variable. Internal economies of scale refer to a fall in unit cost of production when a firm increases output by expanding its scale of production. An increase in scale refers to an increase in the inputs, namely capital and labour, at the same proportion. On the other hand, external ec onomies refer to the fall in unit cost of production experienced by the firm as a result of growth in the industry. R1: Explain internal economies of scale and its link to a firm’s LRAC Figure 1: Internal economies of scale and external economies of scale From Figure 1, the x-axis is labelled as output (which is a proxy for scale of the firm) and the y -axis denotes the average cost. Internal economies of scale are observed when the firm increases its output (scale) from Q0 to Q1, which results in a movement along LRAC0 and causes average cost to fall from C 0 to C1. Internal economies of scale may arise from a few sources, division of labour and specialization, indivisibility of large machines, spreading out “fi xed” costs and bulk purchases. (select 2 sources to elaborate) Sources of internal economies of scale Division of Labour and Specialisation: As the scale of production expands, there is greater scope for specialization of labour & machines. Specialization allows the production processes to be broken down into simpler and repetitive processes. With specialisation and division of labour, productivity improves, and more goods can be produced using the same amount of resources. Moreover, less training is needed (more time can be spent on production) and workers can be more productive in their task and there is less time loss in workers switching from one operation to another and thus lowering unit costs. For example, some workers on the assembly lines for car manufacturing specialise in the installations of bonnet while others in engine and wheels, allowing workers to concentrate in simple and repetitive processes which increases efficiency. Spreading out capital outlay e.g. R&D costs: A large firm will have the resources to support researc h leading to the development of better products & cheaper techniques of production and with the large scale of produc tion, it is able to spread the huge R&D costs over a large output, thereby lowering unit costs. For example, a supermarket chain such as NTUC Fairprice and Sheng Siong can invest in technology that improves stock control, which is not viable or cost-efficient for a small grocery shop to buy this technology.

Suggested Answers to A Level 2024 H2 Economics (ESSAYS) by Hwa Chong Institution Economics Unit Bulk Purchase: Large firms have bargaining advantage and are given preferential treatment by their suppliers because they buy in bulk. Bulk buying of raw materials enables a large firm to obtain the goods at lower costs & better terms, thereby lowering unit costs. A good example would be the ability of the electricity generators to negotiate lower cost when negotiating coal and gas supply contracts. The major food retailers eg. NTUC also has buying power when purchasi ng supplies from farmers and other suppliers. Similarly, the giant Internet retailer Amazon is also able to obtain lower prices for the book s which it purchases R2: Explain external economies of scale and its link to a firm’s LRAC For external economies of scale, a firm enjoys cost savings even if its scale and output remain the same. As the cost savings arise from growth of the entire industry. As seen in Figure 1, when there are external economies of scale, the LRAC curve will shift from LRAC0 downwards to LRAC1. At the same scale and output Q 0, the firm will experience external economies of scale which lowers its average cost from C0 to C2. External economies of scale arise from several sources, including the entry of more firms into a locality and the sharing and dissemination of information among firms. (select at least 1 to elaborate) Sources of external economies of scale When more firms enter to operate at a locality (economies of concentration): When many firms carrying out similar activities are located very close to one another, i.e. concentrated together. For example, many chemical firms can be found in Jurong Island in Singapore. As the industry expands, the demand for labour with the necessary skills increa ses. Training schools may be set up, which means that a pool of skilled workers is readily available and thus reduce total and hence unit costs that are originally incurred by firms to train their employees. Due to the concentration of industry in the region, facilities such as better transport, banking & telecommunication systems may be set up to serve the needs of the industry, thereby lowering operating costs. Shared access to information: Firms can benefit from industry -wide services such as journals, newsletters, or databases provided by trade associations or research centres. These shared resources reduce the cost of obtain ing valuable information, lowering unit costs for firms. Mark scheme To score L3 your need to address the two requirements: ● Explain internal economies of scale with link to a firm’s long-run average cost of production ● Explain external economies of scale with link to a firm’s long-run average cost of production Part (b) Introduction Mergers and acquisitions can be justified from the viewpoint of firms as it generates cost savings which helps to increase firm profitability. It may also generate welfare benefits to consumers in the form of lower prices. However, firms also enjoy revenue advantages when mergers and acquisitions increase the market share of the firm. This essay will discuss how gains in economies of scale may not be the only justification for mergers and acquisitions. R1: Gaining economies of scale is a justification for mergers & acquisitions Mergers and acquisitions allow the merged firm to reap internal economies of scale as the firm can increase its scale of production. As a firm increases its scale of production, this will lead to a downward movement along the LRAC as it reaps internal economies of scale (as analysed in part a). In the short run, this will translate to lower average and marginal costs than before from AC1 and MC1 to AC2 and MC2. Price charged is reduced from P1 to P2 and output transacted larger from Q1 to Q2, where the equilibrium price and output is obtained by equating MC=MR. Supernormal profits increase from P0ABC0 to P1XYC1

Suggested Answers to A Level 2024 H2 Economics (ESSAYS) by Hwa Chong Institution Economics Unit Figure 4: Impact of increasing scale of production in the short run Therefore, the merged firm will enjoy cost savings as its average costs will fall in the long run and if the cost savings is passed on to consumers in the form of lower price, it will also raise consumer surplus, benefiting the consumers Ev1: Over-expansion of the firm will limit the gains enjoyed from internal economies of scale While it is true that merging can lead to internal economies of scale, firms may become too large and unwieldy, resulting in diseconomies of scale. This implies that the merger may have cause the firm’s scale to go beyond the minimum efficient scale, QMES (Figure 1).