MJC 2008 Prelim H2 Qn Paper 1

Additional materials: Answer Booklet/Paper READ THESE INSTRUCTIONS FIRST Do not open this booklet until you are told to do so. Write your name, class and register number on all the work you hand in. Write in dark blue or black pen. You may use a soft pencil for any diagrams, graphs or rough working. Do not use staples, paper clips, highlighters, glue or correction fluid. Answer all questions. At the end of the examination, fasten all your work securely together. The number of marks is given in brackets [ ] at the end of each question or part question. [Turn Over] JC 2 PRELIMINARY EXAM 2008 9732/01 ECONOMICS HIGHER 2 12 September 2008 Paper 1 2 hours 15 minutes This document consists of 8 printed pages

Answer all questions. Question 1 The Airline Industry Extract 1: UK takes to the air Air travel in and around the United Kingdom (UK) has grown by over 60% since 1995. This is largely due to the ways in which low-cost airlines such as Ryanair and EasyJet have introduced new affordable services within the UK. In the main, they use airports that are not widely favoured by more established airlines, such as British Airways (BA). The overall demand for air travel is highly price elastic. The low-cost airlines are not only cheaper than their more established competitors, but also cheaper than the monopoly operator of rail services for the route between London and Edinburgh. Source: Economic Review, Feb 2005 Extract 2: Difficult Times for Industry - But Travel Set to Pick Up The last few years have been difficult for the aviation industry. September 11 was the most severe crisis the industry has faced. Nearly all airlines were unable to cope with the increased cost of added security and higher insurance premiums. Last year, East Asia was hard hit by the SARS outbreak. The airline industry in East Asia lost money for six months because people were afraid of SARS and stopped travel to SARS-affected countries. Singapore Airlines (SIA) had to drastically cut back its flights, especially those to SARS-affected areas. To stop the bleeding, management cut their own and staff salaries, got pilots and cabin crew to take compulsory unpaid leave and so was able to reduce retrenchment to 2%. Nevertheless it suffered its first-ever quarterly loss in April/Jun 2003. For the whole of 2003, passenger traffic fell 14.9 per cent from the previous year. Governments in Asia are beginning to liberalise their air transport regimes. They have seen the potential spin-offs in trade, tourism and investment flows. As has happened in the US and Europe, the winners will be those countries in Asia whose governments liberally exchange traffic rights and expose their national airlines to market competition. Air travellers will have a wide choice of options to choose from, ranging from premium services offered by the full service carriers like SIA and Qantas, to low cost, no frills services offered by low cost carriers like Lion Air and Thai Air Asia. Competition will be in quality of service, pricing, adequacy of networks in terms of frequencies and destinations ie the overall quality of the product. Competitive pressures will force airlines to innovate and reinvent their businesses to become more competitive. Low-cost carriers have eaten into the lower end market share of full service carriers, but has made air travel affordable to a larger group. In the region, low-cost carriers include Indonesia's Lion Air, Malaysia's Air Asia and Singapore's proposed Valuair and Tiger Airways. Low-cost carriers depend on short, point-to-point routes and keeping their costs low so that they can price their air tickets cheaply. They do not require aerobridges and ground handling. They need minimalist check-in counters. Adapted from Address by Senior Minister Lee Kuan Yew, Sunday, 22 February 2004

Extract 3 Case to airlines and agents: Show full fares on ads Singapore's consumer watchdog, faced with a growing tide of complaints from frustrated travellers, wants airlines and travel agents to reveal full air fares in their advertisements. It is wrong to mislead people with low fares when the real cost of travel - with taxes and other fees thrown in - is much more, said the Consumers Association of Singapore (Case). The practice by airlines and travel agents of not being totally upfront with the real cost of air fares has become more blatant since budget airlines made their debut and increased competition for the air traveller's dollar. The final cost of an air ticket today includes not only the base fare - which is really just the cost of the seat on the plane - but a whole host of charges lumped under 'taxes and fees', which include security and airport taxes, insurance and administrative charges and fuel surcharges. These extras can make up more than 75 per cent of the final cost, particularly for budget airlines which have lower base fares. Case president Yeo Guat Kwang, wants the Government to introduce legislation to protect the consumer. Other countries like Australia, New Zealand and Britain already require airlines to disclose full fares in their ads. The need for regulation has also become more pressing in recent years because low-cost carriers operate on multi-tier fare structures that reward early birds with bargain fares. The catch is that consumers do not know how many of such bargain-priced tickets are actually available. And the big airlines are doing the same thing. Karamjit Kaur, Aviation Correspondent, 26th Aug 2006 Table 1: Singapore Airline Operating Results 2002 2003 2004 2005 2006 Operating Revenue ($m) 8,047 7,187.6 9,260.1 10,302.8 11,343.9 Operating expenditure ($m) 7,838 7,037.4 8,562.3 9.651.8 10,316.9 Passengers carried (‘000) 15,326 13,278 15,944 16,995 18,346

Questions: (a) (i) Explain what is meant by the term 'cross elasticity of demand'. [1] (ii) The cross elasticity of demand for low-cost air travel from London to Edinburgh with respect to the price of rail travel is +1.8. Explain what this means. [2] (iii) Explain why 'overall demand for air travel is highly price elastic' and account for its significance to an airline pricing & output decision. [5] (b) (i) Describe the trend in Singapore Airline’s profitability from 2002 to 2006. [2] (ii) Suggest reasons for the trend observed. [4] (c) Using the data provided, discuss the extent to which Singapore Airlines might be adversely affected by the entry of low-cost airlines. [6] (d) In the light of the information provided, assess whether it is necessary for the Singapore government to regulate airfares in the airline industry. [10]

Question 2 The Tale of Two Deficits Extract 1 The trade deficit in UK is giving cause for concern again. Official figures show that Britain’s trade in goods balance was in deficit by 3.6bn in October 2002. In the 305 years of data, stretching back to 1697, it was the worst month on record. So far in 2002, the deficit has been 27bn and, according to the statisticians, there is worse to come. Do the figures, in conjunction with Europe’s trade surpluses tell us that the pound is uncompetitive with the euro? A little, but the main reason Britain’s trade position with the EU has worsened is the weakness of demand in Europe. Unlike other European consumers, the UK consumer has continued to spend, sucking in imports from elsewhere. You might even argue that, as long as we can finance the trade deficit with ease, Britain’s consumers are doing themselves a favour by spending, and doing the rest of Europe some good by being a