PJC_H2_ECONS_P1_Suggested_Ans___Markers_Report

PIONEER JUNIOR COLLEGE (ECONOMICS DEPARTMENT) 1 PJC 2016 H2 Paper 1 Prelim Exam Suggested Answers Question 1: Supermarket Shake Up (a) (i) Explain how real GDP growth can be calculated from the data in Table 1. [1] Suggested answer: Real GDP growth is calculated by subtracting the inflation rate from nominal GDP growth. Real GDP growth = Nominal GDP growth – Inflation Rate (a) (ii) State how the level of real GDP has changed from 2011 to 2013. [1] Suggested answer: The level of real GDP has fallen / decreased from 2011 to 2013. (b) Account for the surge in Aldi’s sales revenue using the concepts of price and income elasticity of demand. [4] Suggested answer: Explanation of how PED accounts for rising Revenue 2 marks Aldi’s groceries (own label, etc) are price elastic in demand (PED>1) due to the availability substitutes / high proportion of income spent on groceries as many consumers have low income during recession / austerity. As Aldi cuts prices, quantity demanded rises more than proportionately thus total revenue (PXQ) rises and surges. Explanation of how YED accounts for rising Revenue 2 marks The economic downturn shows incomes are falling, and Aldi’s goods are inferior goods (own label), thus YED<0 and fall in income leads to rise in demand/Qty demanded, this boosts total revenue too (assuming price remains constant). (c) Comment on whether the pricing behavior of firms in the supermarket price war is in alignment to traditional economic theory. [6] Suggested answer: The firms in the supermarket industry operate in a competitive oligopolistic market structure. There are few dominant firms in the market and each is interdependence in their behavior to the other. According to the traditional economic theory on price rigidity, prices in the market tend to be rigid. As a result, firms in a competitive oligopoly market tend to compete via non-price competition than price competition. According to the theory of price rigidity, when a firm increases his price, his rival firms will not follow suit. This will cause the firm to have a fall in quantity demanded by more than proportionate and his total revenue will fall. Thus, the profit maximizing firm will choose not increase his price. In the same way, if the firm lowers his price, his rival firms will also reduce their prices. Consequently, the firm will have a rise in his quantity demanded by less than proportionate and his total revenue will fall. Thus, the firm will again choose not to reduce his price. This interdependence behavior of the competitive oligopoly explains why firms in this industry do not usually compete via prices. However, as seen in the extract 1, when Aldi reduced its price, the other supermarkets like Tesco, Morrisons, Asda and Sainsbury also cut their prices. This is not aligned with price rigidity as espouses in the theory. However, in the short run, firms may occasionally c