RVHS H2 ECONS P1 CSQ1 Soln

© RVHS 2017 9757 [Turn over RVHS 2017 Y6 H2 Prelim II CSQ1 Suggested Answers ai. Given the information contained in Table 1, ide ntify the region that had the greatest impact on world oil prices. Justify your answer. [3] • Middle East [1] • Total consumption in the Middle East had an overal l percentage increase of 1.31 percent (DD↑) , which was outstripped by its total production which had an overall percentage increase of 5.44 percent (SS↑) • It had the greatest net increase in oil production (i.e. increase in SS outweighs the increase in DD) compared to the rest of the regions given, causing world oil prices to fall . [Award 1m for identifying the region; 2m for justifying the answer] aii. Besides the return of US oil and Libyan oil pu shing up supply, explain one other reason that has contributed to the change in world oil prices. [2] • According to Extract 1, given the current slowdown in the Chinese and EU economies have led to a poor outlook , consumers are not optimistic about their employment prospects for the future. Thus, expectations of lower future income will lead to a fall in their current demand for final goods and services like cars. The derived demand for oil , which is a factor input in the production of cars, will thus fall. b. What can you conclude from the evidence in Extract 1 about the likely value of the price elasticity of demand of oil? [2] • The value of price elasticity of demand of oil is likely to be less than one (i.e. demand is price inelastic) • Given the increase in supply of oil, according to Extract 1, due to the return of US oil and Libyan oil to the market, if demand for oil is price inelastic due to it being a necessity since it (an industrial raw material and commodity) is a key factor input in the production of many goods and services , there will be a sharp fall in prices.

© RVHS 2017 9757 2 c. Explain how OPEC can ‘stabilise prices by cutting production’ of oil. [3] • OPEC, the cartel of major oil producers’ supplies over 30% of the world’s oil (i.e. market share) would fix production quotas among member sta tes. Through the agreement, OPEC effectively acts as a monopoly for oil setting quan tity to be at the profit-maximizing level of output where MC = MR. • However, when price of oil fell, it threatened the survival of smaller cartel members/ “more vulnerable members”. • If OPEC were to cut the production of oil, it will reduce the total market oil supply, propping up oil prices, achieving the effect of stabilising prices. d. Describe the likely market structure of China’s electric car industry. [2] • Oligopoly. There are a few large dominant firms (V olkswagen, BMW & General Motors). OR high barriers to entry (economies of scale, Extract 2) and branding (Extract 4). e. Discuss the factors affecting the choice of comp etition strategies in China’s electric car industry. [8] Firms within the electric car market can undertake competition strategies to increase the level of profits earned. The choice of competition strategie s can be explained by factors such the type of market structure and government regulations. Factor 1: Type of Market Structure One of the factors affecting the choice of competit ion strategies in the electric car industry is the type of market structure . As explained earlier, the likely market structure of China’s electric car industry is an oligopoly. Due to the small number o f dominant firms in the industry, the electric car makers are mutually interdependent where each oligopolistic electric car maker makes its decision based on the reactions of other electric car makers in the same industry. As such, this leads to rival consciousness as they have to be aware of the decisions of other firms so that it can respond accordingly. The behavior undertaken by a non-collusive oligopol y can be explained using the kinked demand curve theory. The model seeks to explain how it is that, even where there is no collusion at all between the car firms, prices can nevertheless remain stable.

© RVHS 2017 9757 [Turn over 3 Based on the assumption that rival firms would matc h any price decrease it makes but not follow it in any price increase, the oligopolist faces a pric e elastic demand curve at prices above P 0 and an inelastic demand curve at prices below P 0. On this assumption, each oligopolist will face a demand curve that is kinked at the current price and outpu t as seen in the above figure. As a result, a rise in price may lead to the electric car firm experien cing a more than proportionate fall in quantity demanded, while a price cut results in a less than proportionate increase in quantity demanded. In both cases, the electric car firm experiences a fal l in total revenue. Since the profit maximising output level is where MR = MC, any change in MC, for example from MC 0 to MC 1, intersects MR at quantity OQ 0 and price OP 0. This results in price rigidity, where the price r emains unchanged over a wide range of costs. Hence, the type of market s tructure is one important factor that affects the choice of competition strategies. Due to the feature of mutual interdependency in thi s market structure, electric car firms avoid any unnecessary price changes. Instead, they choose to compete using non-price competition, otherwise known as product differentiation, to incr ease demand and make demand for its electric cars more price inelastic. As seen in Extract 4, th ere is evidence of car firms exhibiting strategic behavior (i.e. actions taken by firms which are int ended to influence the market environment in which they compete) - “traditional car makers like BMW, Volkswagen and General Motors are developing electric vehicles that are faster, cheap er and boast better range than before,” showing how a firm's research & development and marketing strategies are influenced by what its rivals are doing, in order to maintain or increase profits in the long run. Successful product differentiation increase demand for the firm’s electric cars direct ly, and make demand for its electric cars more price inelastic, allowing firms to charge higher prices and earn higher profit. Factor 2: Changes in government policies Lastly, changes in government policies could also affect the choice of competition strategies. As seen in Extract 4, the central government has also “instituted a new set of policies to encourage competition among domestic manufacturers.” Governme nt policies favouring competition such as Q0 DD = AR C D MR $ Output 0 MR Figure: Profit-maximization of an Oligopolist P0 MC 0 MC 1

© RVHS 2017 9757 4 “subsidies to help smaller companies achieve large -scale production” has helped to increase the level of competition within the industry. Prior to the new set of government policies, the established large electric car firm is able to sell its output at a much lower price which potential new firms are unable to match. This deters new firms from enterin g the industry as they do not have the customer base to warrant a high output level to exp erience the economies of scale enjoyed by an established large firm, so entry is blocked. With g overnment intervention, small firms can now compete with the larger firms and remain in the ind ustry. Such policies may force existing competitors to engage in further product differenti ation to maintain their market share, and the evidence of this can be seen in Extract 4 where “lo cally produced vehicles finally reached a quality threshold”, and “traditional automakers… developing electric vehicles.. faster, cheaper, and boast better range than before.” Evaluation (any one): • According to Extract 2, low oil prices will not ha rm sales of electric cars. This information corroborates with the fact that electric car firms avoid any unnecessary price changes. The low