TJC_H2_ECONS_P1_Mark Scheme

TJC 2014 Preliminary Examinations: H2 Economics CSQ 1 1 Question 1 — The evolution of the US domestic airline industry Suggested answers (a) (i) State the theoretical relationship between market power and prices in an industry. [1] The greater the market power, the stronger the monopoly power, the higher the prices. (ii) Do the data reflect this relationship? Explain why or why not. [5] No, the data does not reflect this relationship stated in a(i) because despite the number of carriers shrinking “from eight or nine big carriers in 2000 to just four” (Extract 2), fare prices generally fell from 2000. [1] Demand factor [2m]  The fall in fare prices (especially between 2008 and 2010) could be due to the subprime mortgage crisis that led to a recession. This resulted in a fall in demand for air travel, which is a luxury good, and hence a fall in fare prices. Cost factors [2m]  Market dominance: as firms consolidate and grow bigger, they are at a better position to reap internal economies of scale (e.g., bulk buy, managerial economies, etc.), and this would result in their AC and MC falling, and hence translating to cheaper prices  Price wars: as the domestic carriers are generally oligopolistic in nature and are therefore mutually interdependent, there is a tendency for them to engage in price wars. This is evidenced in the “fire-sale airfares” (Extract 2) charged by airlines. This might possibly motivate the airlines to continually lower prices to undercut one another, resulting in a price war and hence a fall in fare prices.  Bundling (indirect price discrimination): the fall in fare prices could also be due to the existence of low cost carriers that charge low base fares but high ancillary fees. The low base fares could have lowered the average fare prices. (iii) Describe the trend of the net income of US carriers over the period of 2004 to 2013. [2] -30,000 -25,000 -20,000 -15,000 -10,000 -5,000 0 5,000 10,000 15,000 20,000 25,000 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Total

TJC 2014 Preliminary Examinations: H2 Economics CSQ 1 2  Net income level of the US carriers generally increased over the period of 2004 to 2009 [1]  The net income level of US carriers experienced great fluctuations between 2004 and 2009, but these fluctuations moderated after 2009. [1] (b) (i) Identify how the market structure for domestic US airlines has evolved since the early 1970s. [2] The deregulation of US domestic airlines in 1978 has caused the industry to evolve from a more oligopolistic market structure to a more monopolistic competitive market structure. [1m] However, consolidation in the 2000s has caused the more monopolistic competitive market structure to revert to a more oligopolistic market structure. [1m] (ii) Explain the reasons for the evolution identified in b(i). [4] Deregulation [2]:  The deregulation of the US domestic airline industry was a governme