PJC H2 ECONS P2 Q2 Suggested Ans

PJC 2018 H2 P2 Question 2: Industries, from transport to retail, are being disrupted by new technologies and digital applications. Digital entrants are challenging the incumbents and threatening their bottom lines. a) Explain how advancement in technology may affect a firm’s profits. [10] b) Discuss the extent to which the behaviour of firms is affected by contestability of market. [ 1 5 ] Suggested answers: A firm’s total profit is derived from total revenue minus total cost. With advancement in technology, it can affect both total revenue and total costs. Advancement in technology like that of digital applications can disrupt the businesses and reduce their total revenue. Advancement in tec hnology have allowed digital applications like that of rail-hailing booking applications of U ber to be developed. It has reduced the demand of traditional taxi service of Comfort Delgro. At the same time, there are more substitutes available for Comfort Delgro’s taxi and its demand will become more price elastic. Thus, Comfort Delgro will see its AR and MR curves shifting downwards and becoming flatter. Since TR = P X Q, a fall in DD will reduce both P and Q and TR will fall. [students can insert a dd/ ss or cost/ revenue diagram showing the effect on TR.] As a result, its total revenue will decrease from advancement of technology that disrupt business with digital technologies. On the other hand, technological advancement can also make a firm’s product more differentiated and increases the firm’s total revenue. With the development of technology eg with the development of internet and mobile devices, small firms can tap on more low cost avenues to market their products and reach out to their customers. Product information and review can be shared via social media or blog post. Large firms can tap on improvement in technology to conduct R & D on their product, allowing them to design more sophisticated products that improve on consumer satisfacti on and stand out from its competitors. These strategies made with advancement in technology can increase demand of the firm’s product. At the same time, PED and CED can also be reduced as the firm’s product’s perceived and/ or actual differences are emphasized. With the firm’s demand curve shifted outward and made steeper, the firm will see an increase in total revenue. In addition, the firm can increase the price of its product and the quantity demanded of its product will fall less than proportionately, increasing the firm’s total revenue. Even if the price of the substitute product were to fall, the fall in demand for the firm that has tapped on technology to brand its product will be by a small extent. Thus, total revenue can incr ease if firm position itself well to ride on the advancement in technology by differentiating itself better from its rivals. Technological advancement can reduce costs of firm. Technology improvement has increases computer processing speed and storage capability eg cloud storage, allowing firm to manage larger amount of information at a much reduced costs. Improvements in communication made possible by the internet and devices like laptops and smart phones has streamline the communication processes firm has within and outside with suppliers and customers. The ability to tap on technology to mass produce has also allow firms to enjoy economies of scale. These can increase its efficiency in work processes and reduce units cost. In addition, technological advancement in the form of automation has reduced the need for labour in manufacturing process; significantly reducing costs for many manufacturing and logistic firms. The firm will see a downward shift of its AC and MC curves.

The firm’s supply rise at each output level. Thus, technological advancement can reduce costs for firms in many aspects for firms of all sizes and industries. For a firm that did not anticipate the disruptive forces of advancement in technology and did not make use of technology to reduce its costs, its total profits will likely fall. On the other hand, a firm that utilize technological advancement to increase its reach to its customers and differentiate its product as well as reduce its production cost will likely benefit significantly from the advancement in technology with an increase in total profits. b) Discuss the extent to which the behaviour of firms is affected by contestability of market. [15] Suggested answers: Contestable markets are markets dominated by one or few firms which are operating at competitive price and output levels due to the threat of potential competition/ potential entry of new firms. Contestability of market refers to the ease in which new firms can enter and exit the market. Such a market has no/low sunk costs to allow for the ease of exit. Sunk costs are costs that cannot be recovered when firm leave the industry. Behaviour of firms refers to its pricing and non-pricing behaviour. Non-price behavour will include marketing and research decisions. It is too a small extent that behavior of firm is affected by contestability of market as there are many other factors affecting the behavior of firms. The factors include actions of competitors and government regulation. Behaviour of firms is affected by contestability of market. With low degree of contestability, monopolistic or oligopolistic firm would produc e at the profit-maximising output where MR=MC. With high barriers to entry, monopolisti c or oligopolistic firm will be able to earn supernormal in the long run. Degree of contestability of market has increased with digital applications and technologies lowering market entry barriers across many industries. For example, in the market of retail, non-traditional retailers have entered the retail markets through e-commerce. The taxi service digital applications that makes it easier to match the demand and supply of taxi services allows Uber to enter the oligopolistic market of ride- hailing. Even in traditionally high barrier to entry banking industry, digital technologies have allowed firm like Haier, which is traditionally a manufacturing firm, to offer convenient finance and payment services through its online platform. The increased market contestability has changed the way firms behave. Even through there might not be increased competition yet, the threat of firms entering the tradition industries will change the way firms behave. With high degree of contestability, monopolistic or oligopolistic firm may limit its pricing below profit maximizing level in order to ensure that other firms are not enticed by the large supernormal profits and enter the industry. Instead, it will usually set a competitive price close to / at average cost such that it obtains only normal profit. Ie where AR=AC. However, if the digital entrant’s AC is way above that of the incumbent firm, then the incumbent firm need not reduce its price all the way to below average cost. When competitors do enter their market, monopolists may take actions such as dumping or predatory pricing to drive competitors out of business despite having to make losses and may even attempt a hostile takeover of a competitor.

On non-price behaviour, incumbent firm may choose to make their product competitive and ensure the firm is efficient before any new competitor enter the market. It may do so through marketing strategies to create consumer loyalty before new entrants come their markets. At the same time, it may invest in R & D to streamline its production and improve their product. This will reduce their unit cost and make their demand price and cross inelastic. In face of potential competition, the incumbent firm will be better able to compete via price when it has kept its cost of production at efficient level. With a product that is unique, the incumbent’s demand will fall by less