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HWA CHONG INSTITUTION

Year Two H2 Economics 2014


Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Section F: Case Study Questions for Block Test 2 revision


Question 1 HCI BT2 2010 Q2
Is there room for protectionism?
Extract 4: India Maintains Sense of Optimism and Growth
While most of the world grapples with a crippling financial crisis and a recession, optimism reigns in
much of India as its economy continues to grow. Indias trillion-dollar economy remains a relative
bright spot, some say, in part because the countrys bureaucracy and its protectionist policies have
kept it insulated from the fallout of the global downturn.
Indias fast-acting central bank, which still has room to trim interest rates, has helped ease capital
flows, while the government has stepped in with stimulus spending and tax cuts.
In some regions of the country, the good economic times are not just a distant memory. The market
capitalization of the State Bank of India recently surpassed that of Citigroup, a fact heralded by the
local media. India added 15.4 million cellphone users in January, a record. Rolls-Royce recently
introduced a new model of its Phantom Coupe in India, and BMW opened a showroom in Delhi.
What fueled India has not changed, Sanjay Dhawan, president and chief operating officer of Aricent,
said in an interview. Indias youthful population, domestic demand and business innovation are
helping to carry the country, some economists say. The country is still attracting investors and striking
deals.
However, most optimistic forecasts have not taken into account outsourcing and the millions of people
in India who rely on remittances, or cash sent from relatives working abroad. India receives more than
$20 billion a year in remitted money, the most of any country. Some areas, like the state of Kerala, are
expected to be hit especially hard by the loss of construction jobs in the Middle East. Some predicted
economic growth for 2010 to shrink to 2.6%.
Adapted from New York Times, March 2, 2009
Extract 5: China Builds High Wall to Guard Energy Industry
Calling renewable energy a strategic industry, China is trying hard to make sure that its companies
dominate globally. Just as Japan and South Korea made it hard for Detroit automakers to compete in
those countries giving their own automakers time to amass economies of scale in sheltered
domestic markets China is shielding its clean energy sector while it grows to a point where it can
take on the world.
China has built the worlds largest solar panel manufacturing industry by exporting over 95 percent of
its output to the United States and Europe. But when China authorized its first solar power plant this
spring, it required that at least 80 percent of the equipment be made in China. It has surpassed the

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

United States as the worlds largest market for wind energy, building wind farms using extensive lowinterest loans from state-owned banks.
China was willing to invest heavily in renewable energy industries, even though wind and solar energy
costs are higher than for coal, precisely because it helps the Chinese economy. In addition, Chinas
policies will help address global warming. Chinese-owned companies would increase their share of
the Chinese market by an additional 10 or 20 percentage points this year. That would give them
almost three-quarters of the domestic market, compared with a quarter for European and American
companies the reverse of the ratio four years ago.
Adapted from New York Times, July 14, 2009
Extract 6: When Protectionism is a good thing
Most public discussions of free trade treat protectionism as a dirty word. The recent debates on the
North American Free Trade Agreement (NAFTA) and current debates on the General Agreement on
Tariffs and Trade (GATT) are a case in point. Protectionism to economists usually means protecting
an inefficient, lazy and often monopolistic national industry against really efficient foreign competition
to the detriment of consumers. This kind of protectionism is economically inefficient and should be
resisted.
This does not mean, however, that protectionism is always bad. To the contrary, there are important
instances in which protectionism is an essential precondition even to economic efficiency. The most
fundamental rule of economic efficiency in a market economy is that the full costs of producing a
product must be included in its price. There must be no subsidies.
When the environmental costs of producing a product are passed on to the larger society, this
constitutes a form of subsidy by the society to the producer. When a country requires that
environmental costs be internalized in prices, this is a step toward greater economic efficiency.
However, when a country with policies that support this form of economic discipline engages in free
trade with one that does not, the tendency will be for more and more production to shift to the latter.
Free trade also has enormous consequences for the standards a society chooses for itself that must
be treated separately from questions of pure economic efficiency. Standards regarding the distribution
of income exemplify the issue. After NAFTA was signed the laboring class, which in the United States
suffered a seventeen percent decline in real wages.
Adapted from http://www.globalpolicy.org
Table 2: India
Subject Descriptor
Growth in Gross domestic
product at constant prices (%)
Inflation (%)
Current account balance (% of
GDP)

2005

2006

2007

2008

2009

2010*

2011*

2012*

9.2
4.3

9.8
6.2

9.4
6.4

7.3
8.3

5.7
10.9

8.8
13.2

8.4
5.5

8.0
4.1

-1.3

-1.1

-1.0

-2.2

-2.1

-2.2

-2.0

-2.0

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Budget balance (% of GDP)

-4.0

-3.3

-2.6

-5.9

-6.5

NA

NA

NA

Table 3: Singapore
2006 2007 2008

2009

2010*

2011*

2012*

* Estimated value

Subject Descriptor
Growth in Gross domestic
product, constant prices (%)

2005
7.6

8.7

8.2

1.4

-2.0

5.7

5.3

5.1

Inflation (%)

0.5

1.0

2.1

6.5

0.2

2.1

1.9

2.0

Unemployment rate (%)


Current account balance (% of
GDP)

3.1

2.7

2.1

2.2

3.0

2.8

2.6 n/a

22.0

24.9

27.6

19.2

19.1

22.0

* Estimated value

22.4

22.7

Source: International Monetary Fund

Questions
a) Using Table 2 and Table 3,
i) Compare the trend of Indias current account balance (% of GDP) to that of Singapores for the
period 2005 to 2009.
[2]

ii)

Explain the likely change in the value of Indias currency for 2010 2012.

b)

Account for the difference in estimation of Indias GDP growth in 2010 in Table 2 and Extract 4.
[4]

c) Discuss and compare the impact of the global recession on Singapore and India.

[2]

[8]

d) Explain the possible economies of scale enjoyed by the renewable energy industry in China. [4]

e) In light of the data, to what extent is protectionism justified?

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Suggested Answers
a) Using Table 2 and 3,
i) Compare the trend of Indias current account balance (% of GDP) to that of Singapores for the period
2005 to 2009. [2]
Difference: Indias current account is in a deficit while Spores current account is a surplus (1m).
Similarity: Both initially experienced improvement followed by a worsening of their respective current account
balances (1m).
Comments:
Did not use the appropriate terms to describe current account balance, i.e. used positive for surplus and
negative for deficit.
Students used the words decrease instead of worsening note: a decrease in surplus is worse than before
while a decrease in deficit is an improvement.
Conceptually, at least over a relatively short period of 5 years: A fall in deficits indicates an improvement and
a rise means worsening; for fall in surpluses indicates worsening and a rise means an improvement.
However, a persistent and ballooning surplus is also undesirable. There is no alarming sign of SG surpluses
ballooning in the given data.
Deprove is not a legitimate word and is not the opposite of improve! While disprove is indeed the opposite
of prove, as in you can try to disprove a hypothesis, you should use words like worsen or deteriorate as the
opposite of improve!
ii) Explain the likely change in the value of Indias currency for 2010 2012. [2]
Based on the improving current account (% of GDP), Indias exchange rate ought to appreciate. This is due to
the increase in demand of rupee as demand for exports increase and a fall in supply of rupee as demand for
imports fall.
Data evidence: The most relevant indicator is the BOP. However, in this instance, only the current account is
available.
May accept any possible reasons found in data.
1. Although current account (as % of GDP) improves, current account might worsen as there is GDP growth.
This means that demand for imports may have increased and exports fallen, demand for India's currency has
decreased and supply of India's currency increased, depreciation of currency.
2. The lowered inflation in India signals a more stable economy bringing in more FDIs, demand for currency
increases, leading to an appreciation of India's currency
Not accepted:
There is Economic Growth in India, they will demand for imports hence supply of currency
increases and depreciation. (Need to discuss relative growth rates)
A fall in inflation rate resulted in cheaper export prices and higher export revenue and thus higher
demand and appreciation of rupees. (Need to discuss relative inflation rates).
1m for correct reason 1m for correct prediction. 0m if student only give prediction and incorrect reason.
Comments:
cannot distinguish between internal vs external value of currency
assuming government intervention on the exchange rate

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

b) Account for the difference in estimation of Indias GDP growth in 2010 in Table 2 and Extract 4. [4]
State the difference (1m):
The projected growth in Table 2 8.8% (IMFs prediction)
In Extract 4 last paragraph, some predicted Indias growth to shrink to 2.6% in 2010.
Difference in the growth rate predicted depends on the extent of importance of the external sector on India.
Extract 4 says India is dependent on outsourcing (affects Indias exports) and remittances (affects
Consumption). With the weakened global demand, outsourcing to India may decrease hence affecting Indias
growth through X and less remittances will mean less ability of the Indians to consume affecting C.
3m for relevant evidences and linking to economic analysis.
Comments:
Mere summary of Extract 4 without usage of economic model, i.e. Did not link outsourcing to X or
remittances to C no econ framework will result in loss of marks.
Use NPIA to explain but not according to the Extracts intention
Growth in GDP at constant prices does not take into account inflation hence the growth rate in Table 2 is
higher than the prediction given in Extract 4!!??
c) Discuss and compare the impact of the global recession on Singapore and India. [8]
Introduction
The impact of the global recession has both similar and different impacts on Singapore and India, namely on
GDP, current account, employment and inflation.
Body (Use data 2007-2009)
Compare the data
GDP
Indias GDP growth fell to 5.7% in 2009 but
thereafter is predicted to rise to more than 8%.
Spores GDP growth was negative in 2009 but
is predicted to pick up in 2010, slower than
India.
It seems that Spore is more badly affected by
the crisis than India.

Current account
Spores current account balance fell drastically
by almost 10% from the peak of 27.6% of GDP
in 2007 to 19.1% in 2009, which accounted for
the negative GDP growth. Indias current
account balance has always been negative
which does not affect growth as it is an
insignificant portion of GDP.

Account for the difference using econ concepts and case


material
This is because of the different characteristics of the two
economies. Spore is far more dependent on trade for growth than
India as can be seen by the % that Current Account balance forms
of GDP. This means that the balance of trade (BOT) is of a
higher weighting in the AD for Singapores than in India.
Contrasting this to India where her youthful population, domestic
demand and business innovation are helping to carry the
country. attracts FDIs
Also, many Indians work abroad and remit cash home, which
could be driving domestic consumption at home.
Singapores current account balance is hit more than India most
likely due to a fall in balance of trade (BOT, i.e. X-M) and this is
especially true when Singapores exports are generally
income-elastic and thus when income of top trading partners fall,
the quantity demanded falls more than proportionate.
Moreover, India is well insulated by its protectionistic policies
which seek to reduce M so that AD is bolstered.

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Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Unemployment rate
Spores unemployment rate also rose to 3% in
2009. This is demand deficient unemployment
which is related to the negative GDP growth.

India is very reliant on outsourcing, which is dependent on foreign


firms. The crisis which affects other countries could result in MNCs
reducing their outsourcing to India and reduce the employment of
Indians abroad. That would reduce domestic C in India and
ultimately affect domestic employment.

Note: No data for India.


Inflation (2007-2009)
Inflation rose in India while Singapores fell
from 6.5% to 0.2%.

In 2008, the inflation was most likely due to cost-push inflation


due to high oil and food prices. But when the crisis fully kicked in,
not only did it bring down the price of oil and food, it also result in
lower AD for Singapore and thus bringing the inflation rate
down significantly. As for India, given the strong domestic
demand and probably more supply bottleneck, inflation rate
continued to be high.

Note: Candidates should use AD-AS diagram to illustrate the impact of crisis on Singapore and India. It
is incorrect to draw AD of India and AD of Singapore in one diagram with the same AS.
Conclusion
Generally, there is a negative impact on both Singapore and India but it is more severe in Singapore esp. on her
GDP and current account due to her dependency on trade as an engine of growth while India has a relatively
larger domestic market.
L1
L2

Explanation of how global recession impact Singapore and India separately


Gave a contrast between the impact of global recession impact Singapore vs India with some
reference to case material
L3
Gave a contrast between the impact of global recession on Singapore vs India with excellent
reference to case material and defend with economics concepts.
*cannot angle argument on policies

1-3
4-6
7-8

Comments:
were not able to identify the correct data for use recession was in 2007-2009
use more own knowledge than the case material, especially for Singapore (trade = 4x our GDP)
When there is global recession, it causes prices of raw materials to go up and Singapore being heavily
dependent on imports will suffer from import price push inflation!!!??
Lifting from case without using AD/AS model to explain why Singapore will suffer more than India as a result
of the global recession
Some students compared what was likely to happen instead of using the data to discuss what really
happened
Compare the effects of policies (FP, MP & protectionism) instead of the recession on the 2 ctys
Compare the use of policies in the 2 countries India can use FP, MP & protectionism but Singapore can
only use exchange-rate centred MP to improve the economy after the recession

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

d) Explain the possible economies of scale enjoyed by the renewable energy industry in China. [4]
The context is Industry
External economies of scale are the correct concept as these are costs savings accrued to firms when
the industry expands.
Concentration Good infrastructure e.g. Industrial Park especially to cater to firms in this industry.
Network of supporting industries to provide services to the main industry e.g. banking services; industries to
supply key inputs or raw materials.
Ready pool of skilled or trained workers
Information - Sharing of R + D findings via Trade publications
However, some marks will be awarded for internal economies of scale but the marks will be capped.
Internal economies Technical, marketing, financial, risk-bearing and administrative & managerial.
Examples
Technical Economies due to Research EOS Larger budget for research is spread out over larger output
Large production plants for solar panels give rise to specialization of labour and gains from indivisibilities.
Comments:
Failed to realize the most relevant EOS are external rather than internal EOS.
Merely stating 2 EOS and no elaboration.
Gave general examples with no reference to the renewable energy market. Some could not even explain
generic EOS correctly.
Gave reasons for why China may enjoy EOS instead of explaining the sources of EOS
Never link EOS to fall in unit cost.
Confusion over financial EOS and protectionism: Students explained that the government gives cheap loans
as a form of financial economies. This is cannot be accepted as it is a protectionistic measure adopted by
the Chinese Government to help the industry.
e) In light of the data, to what extent is protectionism justified? 10]
Introduction
Define protectionism.
I shall be using the date to discuss whether protectionism is justified.
Body
Protectionism is justified.
Correct Market Failure
It helps to address global warming in China, hence it
corrects market failure which arises due to negative
externalities. (Extract 5, para 3)
It allows internalization of external costs by the producer,
through the imposition of taxes. (Students are expected to
use the SMB/SMC model). Without protectionism,
governments would be hesitant to impose taxes on
producers to correct market failure, as that would make
them less competitive compared to foreign products which

Protectionism is unjustified
Inefficiency
It encourages complacency and inefficiency among
producers. (Extract 6, para 1)
Consumers suffer in terms of higher prices and
poorer quality of goods. Solar energy industry in
China may not develop a comparative advantage if
they become complacent and inefficient. There
may also be incorrect identification of the solar
energy industry as one with potential CA.

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

are not taxed. (Extract 6, para 2 & 3)


Evaluative comments:
Taxation has problems such as difficulty in measuring EMC so
it is not a long term solution.
Infant-industry argument
It is a strategic industry as it has huge potential to bring
about economic growth to the country.
As compared to US and Europe, the renewable energy
industry can be considered as an infant industry. An infantindustry is a newly established or sunrise industry with
potential CA and huge potential to bring about economic
growth to the country. (Extract 5, para 1)

Prolonged structural unemployment


Low wage workers in the US should be retrained to
take on jobs in other industries. Only a short term
solution, ultimately protectionism makes firms less
efficient and workers has no incentive to retrain to
equip themselves with more relevant skills
India Strong economic performance
India is less affected by the crisis is due to its
strong domestic demand and may not be due to
the protectionism. As a result, to use protectionism
to spur economic growth is not justified.

If it develops a comparative advantage, in the long run due to


ability to enjoy EOS consumers will be better off in terms of
lower prices and better quality products.
Widening Income disparity
Free trade causes a worsening of income distribution. After
the signing of the NAFTA, the laboring class in the US suffered
a fall in wages. This is because labour intensive goods which
can be produced by Mexico floods the US market and
competes with US made labour intensive goods. (Extract 6,
para 5)
Vulnerability to external shocks
Protectionism has helped insulate the Indian economy against
the subprime crisis. On the other hand, SG economy with its
open trade policy is highly vulnerable to external shocks.
Conclusion
Protectionism may be justified as a short-term measure under certain circumstances.
However, it can never be a good justification in the long run under any circumstances because it will breed
complacency; inefficiency and most importantly invites retaliation from trading partners which will result in a no
win situation for all countries concerned. Instead, the government should use supply-side policies to develop
new areas of CA or enhance the productivity of the industries.
L1
L2
L3
E1
E2

Explains the arguments for and against protectionism in a general manner


Explains the arguments for and against protectionism with some references made to the case
material
Max 4 if one sided
Good, balanced analysis based on the case material
Unexplained stand on whether protectionism is justified
Reasoned stand on the whether protectionism is justified

1-3
4-6
7-8
1
2

Comments:
Insufficient use of case material, students gave arguments for and against protectionism based on lecture
notes instead.

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Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Didnt grasp the idea in the extract. E.g. protectionism is justified to internalize externality.

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Question 2 N2007 Qn 2 (1.5 hour)


Supermarket development and competition
Extract 4: Chinas supermarkets present export opportunity
Rising incomes and an expanding urban middle class are setting the stage for Chinas development
as a family market for imported goods. Until recently, many foreign exporters considering the Chinese
market were discouraged after encountering a fragmented market made up of thousands of old-style
family owned shops, open-air markets and inefficient systems for the distribution of imports. The good
news for food suppliers is that supermarketisation is transforming Chinas food sector into a modern
retail system. Modern supermarkets and hypermarkets retail formats nearly non-existent in China in
the early 1990s have now captured an estimated 30% of the urban food market and are growing at
rates of over 30% annually. Chinese supermarkets grew from just one outlet in 1990 to approximately
60 000 stores by 2003.
Supermarkets began developing in China in the early 1990s, encouraged by local governments. Multinational chains from Europe, Japan, Hong Kong and the United States provided a second major
impetus in the development of the sector in the mid 1990s. They have about 40% of the sectors sales
but domestic companies such as Lianhua and Hualian have developed quickly. Local governments
are actively encouraging the transition to supermarket by shutting down traditional street market and
in some cases converting them into supermarkets. In 2004, Chinas Ministry of commerce announced
a five-year plan to develop a rural retail network of supermarkets in small towns.
Imported foods, until recently a rarity in China, are now widely available in Chinese supermarkets.
Chinas growing middle class has the purchasing power to afford imported foods, but this crucial
market segment has been kept largely out of reach of the worlds food exporters by the combination of
Chinas old-fashioned marketing system and high trade barriers. However, China has cut tariffs,
import trading licensing requirements and state trading monopolies as a result of its entry into the
World Trade Organization in 2001. Lower trading barriers are the first step to opening the Chinese
market, but a competitive, efficient domestic marketing system is necessary to get imported products
from entry points to the Chinese consumer. Thats where supermarkets come in.
Source: Fred Gale and Thomas Reardon, Asia Times, 24 June 2005

Extract 5: Let Chinas retail wars begin


In keeping with the conditions for Chinas membership of the World Trade Organization, China has
lifted most restrictions on foreign retailers. Gone are the limits on the number of stores, rules confining
them to large cities and regulations capping the foreigners stake in local ventures at 65%. China
erected those hurdles to give its own companies a chance to copy the Wests big store model and
they have done so with great success. The top four retailers in the country are all run by the
government or local entrepreneurs. But the foreign companies are not far behind and they have big
plans for expansion now that the barriers have come down. Paris-based Carrefour has some 240
stores in China, and plans to open as many as 150 more this year. Its 2003 sales of US $1.8 billion
made it Chinas fifth biggest retailer.

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Consolidation is sweeping the sector, too. Shanghai Ballion, which has nearly 5000 stores, has won
permission to take over four rivals. Beijings ultimate goal is to create a small number of big players
that will be strong enough to compete with the multinationals at home and expand overseas.
Source: Business Week Online, 17 January 2005

Extract 6: Supermarkets in the UK: a model for Chinas retail sector? Tesco may have to sell
off stores
Tesco, the UKs biggest supermarket group, maybe forced to sell off some of its shops in what would
be a dramatic intervention aimed at curbing the retail giants dominance. There is a call for
government regulators to intervene to force Tesco into divestment, the process of selling off stores.
The UKs top four supermarkets have a huge market share which is continuing to grow. In the next ten
years Tesco could have 1200 smaller convenience stores in addition to its large supermarkets. Asda,
one of Tescos major competitors, is poised to follow suit. Ten years ago supermarkets did not
compete in the smaller convenience store market. In the four years to 2004, 7377 independent
convenience shops, more than 20% of the total, closed. In addition, the buying power of the
supermarkets is so great that their suppliers complain that they are forced to sell to supermarkets at
very little profit.
There is certainly a case for divestment, says the policy director at the New Economics Foundation.
The market place is being strangled by the big four. However, a spokesperson for Tesco said, I think
the public interest would need to be looked at in a proper manner by government regulatory
authorities and I would hope that when they talked to us and looked at our operations in detail they
would come to the view that divestment was a bad idea.
Source: Observer, 6 November 2005

Table 4: Top four UK supermarkets: share of grocery sector


Share of Grocery
Sector (by value of
total sales)
Tesco

2004 (%)

2005 (%)

28.1

30.5

Asda

16.6

16.7

Sainsbury

15.4

15.7

Morrisons

13.9

11.3

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Extract 7: Supermarkets in Singapore: the food retail sector


For many years the food retail sector has been dominated by wet markets and general grocery
shops, but this pattern is changing with the rapid expansion of modern supermarkets. NTUC Fairprice
and the Dairy Farm Group are the two largest supermarkets for retail food. Cold Storage and Shop
nSave supermarket chains are subsidiaries of the Dairy Farm Group.
Wet markets still represent the bulk of sales of products such as vegetables, seafood, rice, eggs and
chicken, while dedicated fruit shops still sell most of the fresh fruits. However, supermarkets are
gaining market share in all retail food products.
Singapore has a significant domestic industry manufacturing a range of food and beverages, but
virtually all raw materials are imported, as there is almost no local agricultural production. Singapores
multi-racial society and the presence of a large expatriate population have led to a diverse and rich
variety of food types being available to customers.
Source: Australian Government: Austrade, Guide to Australian Exporters Webpage 2005

Table 5: Singapore retail sector: retail sales index for selected types of outlet
Index at Current Prices (1997=100)

Type of outlet
Department
stores
Supermarkets
Provision
and
sundry shops
Total retail sales

2000

2001

2002

2003

2004

104.3

99.9

100.4

99.6

108.4

123.0

138.3

147.1

158.5

151.1

100.6

104.6

109.6

113.8

123.2

128.4

133.1

129.8

140.9

158.6

Source: www.singstat.gov.sg

Questions
(a) Compare the change in retail sales in Singapore by type of outlet between 2000 and 2004. [2]
(b) Explain two reasons why supermarkets are growing so quickly in China.

[4]

(c) (i) Describe the type of market structure operating in the UK grocery sector in 2004.

[2]

(ii) Explain how the firms in this market might compete against each other.

[4]

(d) Discuss the policy of divestment in the case of Tesco explaining clearly how this might affect
consumer welfare.
[8]
(e) In the light of the data provided, if you were an economic advisor to the Singapore government,
would you recommend that it should follow the example of the Chinese authorities and encourage
supermarket development? Justify your answer.
[10]

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Suggested Answers
(a)

Compare the change in retail sales in Singapore by type of outlet between 2000 and 2004.
Suggested answer:
Similarity: Retail sales in Singapore increased for all 3 categories between 2000 and 2004. [1m]
Difference [1m]:
Retail sales for Supermarkets increased at the fastest rate by about 23% while that of Department
Stores at about 4%.
OR
Retail sales increased the most for Supermarkets and the least for Department stores.
Note: Though supermarket experienced the highest increase, it does not mean the sales is
the highest. We need absolute figures to be sure.
Teaching point: Use of index nos. For weaker classes, teachers might want to provide additional
exercise for students to try on the spot. One good exercise would be Nov 2008 qn ai & aii)
Table 5: Singapore retail sector: retail sales index for selected types of outlet
Index at Current Prices (1997=100)

Type of outlet

2000

2001

2002

2003

2004

Department stores

104.3

99.9

100.4

99.6

108.4

Supermarkets
Provision and
sundry shops

123.0

138.3

147.1

158.5

151.1

100.6

104.6

109.6

113.8

123.2

Total retail sales

128.4

133.1

129.8

140.9

158.6

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[2]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Calculations:
Department stores
Supermarkets
Provision and sundry shops

108.4-104.3/104.3*100 = 3.93 4
151.1 123.0/123*100 = 22.85 23
123.2 100.6/100.6*100 = 22.47 22

Note: The base year is 1997 and not 2000. We need to perform the above calculations to see
the % change from 2000 to 2004.
Examiners report:
In response to this question candidates simply needed to make comparative statements on the
changes in retail sales by type of outlet. Acceptable comments included the facts that sales had
risen in all types of outlet over the period, sales had increased most in supermarkets and sales
had increased least in departmental stores. Candidates did not do well if they simply observed the
changes rather than making comparative comments. A surprising number of candidates
misinterpreted the data here. Many thought that sales were highest in supermarkets, others that
the data showed price changes in some way. Careful and thoughtful interpretation of the data was
required to score both marks available.

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

(b)

Explain 2 reasons why supermarkets are growing so quickly in China.

[4]

Suggested answers:
Increase in Demand
1. Rising incomes
The increase in incomes of the middle class in urban areas, allowing them to purchase more
imported goods which are available usually in big supermarkets. These goods are likely to be
positive and income elastic and demand will rise more than proportionate with income.
2. Government intervention
The Chinese government encourages supermarkets by shutting down street markets, and thus
inevitably forcing consumers to shop at supermarkets and thus increasing the demand for
supermarkets.
Increase in supply
Lower trade barriers with entry into WTO
Easing on rules to set up firms in China and imports like grocery products, attract more
international firms to set up supermarkets in China and thus increase the supply of supermarkets
in China.
*1m for the identification of a factor and a further mark for an explanation
Examiners report:
This question was well answered by most candidates. Few were unable to identify and then
explain the reasons for the development of supermarkets in China since the reasons were so
clearly signposted in the text. Most candidates scored well, although the Examiners are less
impressed by those who paraphrased the text extensively. They preferred answers that were
succinct and to the point, whilst at the same time answering the question in sufficient depth.
(ci)

Describe the type of market structure operating in the UK grocery sector in 2004.
Suggested answers:
The market structure in the UK grocery sector would be an oligopoly [1m] because four
supermarkets dominated the market with MCR4 = 74%. [1m]
Note: To justify whether the market structure is indeed oligopoly and once a table of market
shares by different firms is given, it is a MUST to calculate MCR. MUST link MCR to a few
dominant firms which is a unique characteristic of oligopoly beside mutual
interdependence.
Examiners report:
This question was also answered very well. Most candidates identified the market structure as
oligopolistic and justified this in terms of the small number of firms controlling the large share of
the market as shown in the data.

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[2]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

cii)

Explain how the firms in this market might compete against each other.

[4]

Suggested answers:
2m for explaining why firms will use non-price competition rather than price due to mutual
interdependence (Cambridge highlighted many candidates left out this point)
2m for elaborating on non-price competition (link it to increasing in demand and reduce
PED)

Firms in this market would choose to engage in non-price competition due to mutual
interdependence.
There are only a few firms under oligopolistic market structure and thus each firm has to
take into account the actions/reactions of other firms and as a result, there is price
rigidity.
If an oligopolistic firm increases price, other firms will not follow and it will lose its
consumers to the competitors, and quantity demanded will fall more than proportionate
leading to a loss in revenue. If it reduces price, other firms will respond by reducing their
prices as well and the quantity demanded will increase less than proportionate and result
in lower revenue for all.
Hence, oligopolies will more likely engage in non-price competition.
They would compete through advertising in the media to create increased brand
recognition for their supermarket.
They would also attract new clients and retain existing clients through special promotions
and marketing strategies by having lucky draws or having a system that recognize
customer loyalty so as to increase demand for their products.
By offering services that are unique to their consumer base such as free home deliveries
for senior citizens, phone-in or online orders, they would also ensure that demand for
their products are more price inelastic.

Examiners report:
In response to this question candidates showed knowledge of the ways in which firms compete in oligopoly, but
these were often described rather than explained. The kinked demand curve was often introduced together with
the statement that it deterred firms from competing on price. This usually led on to a description of types of nonprice competition such as advertising or special promotions or types of collusive behaviour. What was often
lacking here was the underlying explanation of why these types of competition arose in this type of market. The
reason is the mutual interdependence or rival consciousness caused by the fewness of the firms in the market.
Although this could be inferred from the kinked demand curve diagrams that were usually provided, it was very
often only implied rather than explained.

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

(d)

Discuss the policy of divestment in the case of Tesco explaining clearly how this might
affect consumer welfare.
Note: This is a typical Higher Order Skills question. So it should be written in a form of
mini-essay.
The style and approach would be similar to writing an AWEsome essay using thesis, antithesis and synthesis for structure.
General Mark Scheme for 8m HOS Questions:
L3
Elaborate (Extend to include analysis)
Analyse use relevant theory to aid explanation
Apply place explanation in context of evidence from the data
Balanced view
Justified conclusion
L2
Consolidate (Add some details application)
Explain the economic concepts more in depth.
Clarify give examples from data with more elaboration
Consider both sides but lopsided
No justified conclusion.
L1
Knowledge/Recognise (Description)
Identify the key theory without explanation or/and key evidence without
explanation
Outline: give a list of relevant factors
Consider 1 side no evidence of discussion.

78

46

13

Tips: Use SE3DS


State
Elaborate with economic analysis
Evaluate
Exemplify with evidences from
Data
Stand
Examiners report:
This question was generally done well, particularly by those who had a good grasp of the
underlying conceptual framework. Divestment is a policy proposed in the UK to introduce more
competition into the retailing sector. With more competition it would be expected that prices
would fall and output would rise and that this would improve consumer welfare. An
alternative argument is that divestment would reduce the size of Tesco leading to the loss
of economies of scale and higher prices. This would result in an overall loss of consumer
welfare. Similarly, with lower profits, Tesco would be less able to engage in research and
development and again consumers would be disadvantaged. To score in Level 2 on this
question it was necessary to show an appreciation of both possible outcomes in terms of the
impact of divestment upon consumer welfare. The mark awarded within the band was dependent
upon the quality of the answer in terms of technical grasp and the range of issues considered.

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[8]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Introduction
The policy of divestment arose because there is increasing concentration of market power for
supermarkets as they start operating small convenience stores, leading to the closure of many
independent smaller stores.
In addition new firms may not be able to enter the market as the current large supermarket chains have
a cost advantage over independent convenience stores.
- I shall be discussing how the policy of divestment in the case of Tesco explaining clearly how this might
affect consumer welfare.
Body
Thesis Divestment in the case of Tesco will have Antithesis Divestment in the case of Tesco
a positive impact on consumer welfare
will have a negative impact on consumer
Explain the gain in consumer surplus when more welfare
competition is introduce (using a diagram comparing
PC vs monopoly)
By setting up convenience stores in these
areas, the larger supermarket chains have a
cost
advantage
over
independent
Price/revenue/costs ($)
convenience
stores
due
to
their
ability
to reap
MCM = SSPC
substantial EOS.
The divestment for Tesco (selling off of their
convenience stores) actually will result in less
of ability to reap EOS.
PM
a
This may then lead to higher prices (P1 to P2)
due to increase in cost of production for Tesco
PPC
b
when it could not enjoy the same amount of
EOS
Fall in EOS reaped from Q1 to Q2
Price/revenue/costs ($)

MC1=
MR SSPC
0
P2
P1

QM
-

QPC

MCM

AR
output

Comparing the price and output of a highly


competitive firm to one with monopoly power,
price is lower since PPC < PM and output is higher
since QPC > QM.
Area PMPPCab is gain in consumer surplus when
more competition is encouraged

Note: In the explanation, make it clear that the PC


MRonly as a theoretical
AR
model is used
benchmark. It
does not represent the real supermarket. The
Q Q
output of introducing
purpose2 is 1to highlight the benefits
more competition to a market that is dominated by
either one or few sellers. It does not imply that the
number of sellers has got to be small and many.
Thus, instead of saying if there is perfect
competition, it is best to say if there is more
competition or if the market is more
competitive.

Fall in profits for Tesco after divestment could also


lead to a fall in R&D expenditure, leading to a loss
in consumer welfare.

Possible increase in variety of goods and Extent of improvement in consumer retail


services/ improvement in consumer retail experience
experience
Fall in profits for Tesco after divestment could also

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

With increased in competition, supermarkets such as


Tesco might may to increase the variety of goods sold
in the existing outlets to retain or even increase their
market share.

lead to a fall in R&D expenditure, perhaps in the retail


experience (e.g. self check-out counters; online
grocery shopping platform, leading to a loss in
consumer welfare.
EV: However, if it allows for other existing
supermarkets to earn higher profits / lower BTEs
for new players, the overall consumer retail
experience may not worsen.

Stand (include LR analysis)


The extent of improvement in consumer welfare depends on the no. of stores that are sold and
hence how it affects its market dominance. As Tesco is a dominant firm with market share of
about 30.5% in 2005. Even with divestment, Tesco is likely to be able to have substantial buying
power and ability to reap marketing economies of scale. Hence the overall price is likely to fall
and output is likely to increase, resulting in increase in consumer surplus.
With increased in competition, Tesco is also unlikely to reduce expenditure to improve consumers
retail experience to capture greater market share with existing outlets. Hence, variety of goods
sold in the market is likely to increase.
L3 (6-8)
Excellent explanation with economic analysis using diagrams where appropriate.
Balance view and synthesis.
L2 (4-5)
show understanding of divestment and will explain why it could either raise or
lower consumer welfare
L1 (1-3)
show understanding of divestment but will only explain one possible outcome in
terms of consumer welfare
(e)

In the light of the data provided, if you were an economic advisor to the Singapore
government, would you recommend that it should follow the example of the Chinese
authorities and encourage supermarket development? Justify your answer.
Note: There is not much evidence in the case material. This question requires certain own
knowledge to do well.
State

Explain
Exemplify
With Data

Introduction (clarify what the China government is doing & the criteria
for assessing whether Singapore should follow suit)
The China government is encouraging supermarketisation and closing down
traditional street markets. Whether the Singapore government should follow
suit would depend on the economic situation in Singapore.
Advantages
of
developing
supermarkets & Chinas rationale
- The
Chinese
authorities
encouraged supermarketisation
because the existing retail
system was inefficient and
inadequate for the development
of the economy.
- Growth and modernization of the
retail
market
also
lacked
direction as the ownership of

Compare it with the Spore


situation
- The
existing
situation
for
Singapore is quite different from
that of China's.
- Singapore is made up of a very
small area with a good network of
road for distribution of goods
required in the retail market.
- Currently, Singapore already has
3 dominant local supermarket

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[10]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

these small shops was largely in


the hands of individual families.

Elaborate
with
ECONOMICS
analysis
COST &
REVENUE
advantages

One solution to these problems is to


replace them with a few large
supermarkets.
COST advantage
Such supermarkets would also be in
a better position to handle the
paperwork and the distribution
network for imports => can reap
internal EOS
Elaborate on 2 internal EOS reaped
by supermarkets
REVENUE advantage
Large supermarkets will more likely
to have higher revenue and
resources to engage in activities that
further increase its demand.
They can engage in advertisement to
establish their brands and create
better
awareness
amongst
consumers, introduce new, more and
better products, install self-payment
machines to speed up payment. All
these aim to make shopping at
supermarket a better, faster and
more convenient experience as
compared to traditional shops. And
when consumers deem it as a better
substitute,
the
demand
will
increase leading to more revenue.

Explain
Exemplify
With Data

At the same time, the demand will


also be more price inelastic and so
even if the supermarkets charge a
higher price, quantity demanded will
fall less than proportionate and
revenue will increase.
One other reason why China has
consolidated
the
supermarket
industry is to gain comparative
advantage in that industry to allow
those firms to compete in world

chains, namely NTUC, Cold


Storage and Shop N Save coexisting with wet markets stores
(which
complement
the
supermarkets) and a dwindling
number
of
neighbourhood
provision shops.
- As the industry is dominated by 3
large supermarkets, they are
reaping EOS and revenue
advantages.
- The number of independentlyowned neighbourhood provision
shops has been declining over the
years. In fact, many shop-keepers
have opted to be a part of a
franchise such as Econ Minimart
to enjoy more EOS since
promotions
of
sales
and
advertising is done by the
franchiser.
As a result, there is no urgent need
for the government to intervene.
In fact, for Singaporeans, the decline
of neighhbourhood shops would mean
fewer choices for consumers.
The supermarket way of running a
convenience store would rule out
possibility of special request that
could be accommodated by an owner
who knows the client and is in a
position to act on his request e.g. to
bring in a brand of a commodity (e.g.
a special brand of dog food) in small
quantity.

May not be the case in Singapore as


supermarkets are more to serve the
domestic market.

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Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

market.
Evaluation

Synthesis/
Stand

The cost savings between supermarkets and neighbourhood shops are still
not substantial since there is more marketing EOS rather than technical EOS.
Consumers are willing to pay slightly more in neighbourhood shops for the
convenience they offer. So, supermarketism actually reduces consumers
welfare.
Note: Saucer shaped LRAC for co-existence of big and small firms.
- From Table 5, we can see both supermarkets and provision and sundry
shops increased healthily by 22-23% even when there is no government
intervention.
- As the economic advisor for Singapore, I would say that Singapore has
different needs from those of China in terms of supermarket development
and should not follow suit.
- I would recommend a non-intervention approach, allowing both the large
firms and the small firms to operate simultaneously.
- Ultimately, in the long run, market forces would allow only the fittest firm
that is most cost efficient to survive.
-

L3 (6-8)
L2 (4-5)
L1 (1-3)
E2 (2)
E1 (1)

The neighbourhood provision shops that survived would be those that


have a niche market where the demand curve is more price inelastic
while the supermarkets will continue to compete among themselves to be
more cost efficient.
Nonetheless, if the supermarkets indeed become too monopolistic and
there are evidences of consumer exploitation, there many be a need to
follow the UK model of divestment instead.

Provide a balanced view and include both the advantages and disadvantages of
further supermarket development with economic analysis. These will be
considered in the context of the Singapore economy.
Provide both advantages and disadvantages but then to be lopsided. Explanation
still lacks economic analysis.
One-sided and discuss only the advantages or disadvantages of supermarket
development and/or there will be limited reference to the Singapore economy.
This level may be characterized by a no of descriptive points drawn from the data.
make a recommendation based upon a sound examination of the costs and
benefits for the Singapore economy of further supermarket development. Expect
comparisons between Singapore and China and UK.
make a recommendation but only the costs and benefits are considered. There
may be points made that are not based upon evidence. There will be only limited
comparison with China.

Examiners report:
This question gave candidates the opportunity to consider the arguments for and against
supermarkets in the Singaporean context. The data provided two examples of different
government policies towards supermarket development. In China, government policy has been to
encourage supermarket development in a variety of ways. In the UK, the government is

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

considering a policy to reduce the market power of supermarkets. Candidates were questioned on
these opposing approaches in the earlier questions. The reasons for the differing approaches to
policy are clearly related to the differing conditions in China and the UK. Clearly whether further
supermarket development was appropriate for Singapore depended on the circumstances in
Singapore. An appreciation of this was essential for a successful answer here. Some candidates
did very well. They considered the data provided as a whole and recognised the underlying
themes and issues. For example, it was clear from the data that the reason that the Chinese
government encouraged supermarket development was that the distribution of goods in China is
inefficient. This was because of the fragmented market. This could hardly be applied to Singapore,
where the wet markets appear to complement other retail outlets. Successful answers considered
such issues in an analytical framework. Good candidates provided a thoughtful conclusion after
summarising the issues from a Singaporean context. The less successful approaches simply
provided a few arguments for and against supermarkets with little reference to Singapore. These
approaches were usually descriptive and failed to grasp the relevant themes inherent in the data.
They tended to focus upon a limited section of the data and failed to consider the data as a whole.
These tended to be awarded a mark in the lower level and often they scored few marks for
evaluation

Question 3 HCI BT2 2010 Q1


Recent developments in Air Travel
Extract 1: The Big Green Dilemma
No one disputes that flying causes carbon emissions, as well as other consequences such as noise
pollution for those who live near airports. According to the 2006 Stern Report, flying accounts for 1.7%
of all global greenhouse emissions but power stations account for a massive 24% and other forms
of transportation (shipping, train and road) for 12.3%. At the same time, there are benefits from flying
for example, tourism worldwide employs around 230 million people and generates 8-10% of world
GDP. Flying is not always the worst choice environmentally, and it is very complex to analyse how
different forms of transport compare, though it is suggested that flying is generally about nine times
worse than taking the train and three times worse than a car with two passengers.
To counter this problem, European governments have started trading carbon permits to limit amount
of emissions into the atmosphere. Singapore also takes a very serious stance to maintaining a
successful global deal in the reduction of carbon emissions. However, Singapore is a "geographically
disadvantaged country" that depends highly on the external sector. The need to travel by air has
significantly increased with the rising affluence of the people and the growing amount of business
done between Singapore and the rest of the world.
Source: The Observer, July 2007 and
MFA press release Singapore Announces Climate Change Target, 02/12/2009

Chart 1: Singapores Carbon Dioxide Emissions, 1990 2007

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Mt = Million tonne; t = tonne

Source: Ministry of the Environment and Water Resources,


the National Climate Change Strategy and the Singapore Department of Statistics

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Extract 2: Analysis of the global airline industry


The airline industry in most countries globally has been deregulated such that entry barriers for new
entrants are lower. Airlines are now free to negotiate their own operating arrangements with different
airports; enter and exit routes easily; and set fares and flight volumes according to market conditions.
Established airlines hold the monopoly over time slots for landing and take-off at certain airports,
making it harder for new airlines to infiltrate.
In an era when airlines are losing billions of dollars amid volatile fuel prices and a pullback in
spending, every carrier is looking to cut costs and increase scale, without having to change prices.
Limited by restrictions on mergers with foreign airlines and waiting for someone else to make the next
move, airlines are now seeking to expand their alliances and trying to extend synergies within current
partnerships.
The three major alliances -- Star, SkyTeam and oneworld -- are global networks of carriers that allow
members to streamline costs while sharing revenue.
Revenue in the Asia-Pacific region has grown by 9.6% in 2008 to reach $101.1 billion. Passenger
traffic also grew by 11.8% in 2008 to reach a volume of 526.3 million passengers. Analysts attribute
much of this increase to the airlines using the internet to enhance the booking of tickets online. The
internet has increased the competitiveness of the airline industry; allowing consumers to compare
prices across airlines prior to booking. Others say that the internet has aided the airlines in achieving
greater revenues through the practicing of price discrimination.
Source: Adpated from Datamonitor, December 2009 and
Airline alliances becoming the new "mergers", Reuters, 26 Feb 2010

Table 1: Top 4 Airlines in Asia-Pacific Region


Share of Asia-Pacific Airline Industry
(by value of total revenues)

2007
%

2008
%

Japan Airlines

24.13

21.32

All Nippon Airways

15.62

14.22

Qantas Airways

13.74

13.38

Singapore Airlines

11.11

11.16

Source: Datamonitor, December 2009

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Extract 3: Low-cost expansion


Full service carriers everywhere are struggling to stay afloat, with Japan Airlines succumbing to
bankruptcy only last month. In contrast, the region's low-cost airline sector is buzzing with passenger
growth and expansion plans. The underlying drivers of the boom for low-cost carriers appear to be in
place: rapid growth in gross domestic product and gradual route liberalisation, which allows airlines to
fly to more destinations.
For the moment, many of the Asian no-frills carriers are declaring profits. AirAsia booked a net profit of
RM$130m (US$37m) for the quarter to September, and Cebu Pacific posted net income of 1.8bn
pesos (US$38m) for the first half of 2009. Tiger Airways, partly owned by Singapore Airlines, says it
makes money from the low-cost operation out of Singapore in spite of rising fuel costs. Such carriers
undercut prices at major airlines by using aircraft more frequently, packing in more seats, selling
tickets directly via websites rather than travel agents and cutting in-flight services.
Source: The Financial Times, February 2010

Questions
(a)

(i)

From Chart 1, compare the trend of Singapores carbon dioxide emissions and carbon
dioxide emissions per capita from 1990 to 2007.

[2]

(ii)

State a reason for the difference observed in (a)(i).

[1]

(iii)

Evaluate measures that the Singapore government can adopt to deal with the alleged
negative externalities of air travel.

[8]

(b)

Using Extract 3, analyse how the market for air passenger travel in Asia Pacific has changed.

[4]

(c)

Explain how the internet has affected the ability of the airlines to practice price discrimination.

[4]

(d)

(i)

The Asia-Pacific airline industry has been described as oligopolistic. What evidence
in the data supports this?

[1]

(ii)

Discuss how the firms in the airline industry might compete against each other and
how this might affect the society.

[10]

(i)

From Chart 1, compare the trend of Singapores carbon dioxide emissions and carbon

(a)

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[2]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

dioxide emissions per capita from 1990 to 2007.

Similarity: Both are increasing


Difference: However, the CO2 emissions increase at a faster rate than CO2 emissions per
capita

Note for tutors:


Emphasise the use of words like both for similarity, connecting word such as however for
contrast and remind the rate of change is usually a good way to show difference.
.
(ii)
State a reason for the difference observed in (a)(i).
Since CO2 emissions per capita rises slower than CO 2 emissions, this mean that population
in Singapore over the time frame must have increased at a slower rate than increase in CO 2
emissions.
Note for tutors:
CO2 emissions per capita = CO2 emissions / population.
In the actual BT2, most students stated population increased at a faster rate which is wrong!
Below is a numerical example that helps you to illustrate:
CO2 emissions = 10
Population = 5
CO2 emissions per capita = CO2 emissions / population = 10/5 = 2
1. If population increases at a faster rate:
Double CO2 emissions = 20
3x increase in Population = 15
CO2 emissions per capita = CO2 emissions / population = 20/15 = 4/3 = 1.33
If population increases at a faster rate, it will result in a FALL in CO 2 emissions per
capita. This is wrong as the CO2 emissions per capita is rising and not falling.
2. If population increases at a slower rate:
Double CO2 emissions = 20
50% increase in Population = 7.5
CO2 emissions per capita = CO2 emissions / population = 20/7.5 = 2.67
If population increases at a slower rate, it will result in a gradual increase in CO 2
emissions per capita.
3. If both increase at the same rate, CO2 emissions per capita will be constant.

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(1)
(1)

[1]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

(iii)

Evaluate measures that the Singapore government can adopt to deal with the alleged
negative externalities of air travel.

Show a 3.27 min video from http://www.youtube.com/watch?v=I1sNaUuLmPM uploaded by


The Air Transport Association (IATA) on May 25, 2010
Note for tutors:
For such Higher Order Skills Question, remind the students to use the following steps:
1. Come up with the economic framework.
2. Insert evidence from the data
Also, looking at the marks awarded, 8 marks warrant 2-3 policies with limitations and final
judgment. Since this is a case study, use measures that are mentioned in the data.
A possible framework:
Negative externality in air-travel: Air and noise pollution
Possible Measures
Trade permits (Extract 1, para 2)
Taxes and more specifically, green tax
Benefits and limitations
Benefits and limitations
Conclusion (Suggest long-term solutions)
Suggested Answers
Introduction
Air travel gives rise to environmental costs resulting in misallocation of resources.
Identify and explain the 2 types of negative externalities.
Air pollution: CO2 emissions that has harmful spillover effects e.g. ill effects on health;
respiratory disease.
Noise pollution: Harmful spillover effects e.g. those living near the airport disrupt sleep; daily
routine e.g. study.
I shall evaluate the measures the Singapore government can adopt to deal with the alleged
negative externalities of air travel.
Green or Carbon tax (How it works)
Limitations
Tax based on carbon emission from aviation Government failure: Difficulty in measuring the
fuels e.g. $X tax per litre of fuel.
pollution accurately so as to fix the tax at the
socially optimal level. Technically, it would be very
Tax closed the divergence between private challenging to measure pollution at high altitude
and social cost of production: i.e. bring private involving the use of a common resource i.e. air
and social cost into alignment. Outcome => space.
social optimal output where MSC=MSB.
Questions:
Whose skies exactly are the airlines polluting?
In view of optimal resource allocation,
E.g. Once an SIA A380 takes off from Changi
travelers or airlines are made to internalise
Airport, it may be polluting the skies of other
these external costs since they are not
countries!
accounted for in their private costs: How to clean it when air is a common
passengers (cost of the air-ticket)/airlines
resource? And in this case worse, it is high
(cost of operation such as salary to cabin crew
altitude pollution! Who should clean the air?
and fuel costs).
Should it be the country that has the skies
being polluted, the airlines or the country that
gets the money from the permits/taxes?

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[8]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Extract 1: Demand for air travel increases with


rising income e.g. by 11% in 2008. Hence
measures that aim at curbing the airline output to
meet pollution targets will meet with severe
constraints giving the growing demand for air
travel.
Tradable permits (how it works)
The permits are a form of quantitative
restriction and they are marketable or
tradable.
The governments job is to determine the
maximum permissible efficient level of
pollution (i.e. fixed the quota) and leave it to
the market to distribute the quotas efficiently
amongst the airlines.
Each polluting firm must buy a permit which
gives it permission to emit a certain amount of
pollution. If not, it will have to clean up the
pollution.
The price of each permit will then be
determined in the market. The higher the price
of permit, the greater the incentive for the
firms to reduce emission.
Marketable permits give airlines the incentive
to find ways to cut down emissions so that
they can avoid having to buy the permits or
they can sell/monetize the unused permits to
airlines who encounter difficulties cutting down
their emission level.
Regulations (how it works)
Rules to curb pollution

Over-tax or under-tax wont resolve the problem.


Limitations
Difficult to ascertain the socially optimal level of
pollution in order to determine the quota or max
permissible level of pollution.
Compliance issue. Firms might not stick to the
quota. Enforcement is required. But, difficult to
measure pollution accurately to determine
infringements has occurred.
Require
infrastructure
i.e.
institutional
arrangement to facilitate carbon trading.
Negative impact:
Large airlines may use this platform as an
opportunity to engage in anti-competitive acts to
ooze out smaller players buy bidding very high
price for the permits. (Smaller airlines without
permits will not be able to fly!)

Limitations
Compliance issue e.g. monitoring and deterrence

Eg: The regulatory body could Impose physical


limits on the number of flights to and from
airports within their jurisdiction. OR impose fuel
efficiency targets on airlines; eg. airlines must
have introduced fuel efficiency methods in 5
years time which would reduce fuel per
passenger mile from their current levels;
packed the seats per aircraft say till 80%
before it is allowed to take off; pilots must land
the plane more economically
Straightforward to devise, easier to understand
by firms and easier to implement.

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Conclusion
Use environmentally friendly fuel and aircrafts
Use Green fuels
Technological solution
LT best to resolve the problem at its source. The basic source of air pollution comes from the use
of dirty or fossil fuels. Government can encourage the development and use of green fuels via
subsidies for R +D and adoption.
Noise pollution
Similarly government can encourage the development and use of environmentally friendly aircrafts
e.g. quieter engines. Citing airports away from residential areas e.g. Changi Airport is located near
the sea to minimize noise and air pollution.
Essentially, high altitude pollution may worsen global warming which affects EVERYONE. This calls
for a consolidated international effort in reducing it and thus funds will be collected to pump into R &
D to come up with more environmentally friendly aircrafts or biofuel.

*to score level 3 marks for this question, students must evaluate 2 measures, of which 1 must be from the
text (marketable permits).

(b)

Using Extract 3, analyse how the market for air passenger travel in Asia Pacific has changed.
Note to tutors:

Highlight to students the question is on the market of air travel and the correct
economic framework is DD-SS analysis.
Last year, many students used revenue-cost framework.
So this question requires answers that shift demand and supply.
Base on the data, there is more air travel and prices are lower, it means there is an
increase in demand and supply but the increase in supply outweighs demand.
Also, always use words such as From Extract 3, para 1 to show the examiner you
are indeed using information from the data.

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[4]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

State
Change in demand (1m):
Ext 3, para 1: rapid growth in GDP leads to an
increase in demand for air passenger travel

Elaborate
Increase in income signals an increase in
purchasing power and since air travel is a
normal good, the demand rises when income
increases.

DD - P and Q
Change in supply (2m):
Ext 3, para 2: Presence of low-cost carriers Since this means an increase in number of
such as Tiger Airways, Cebu Pacific and service providers.
AirAsia increase the supply
SS - P and Q
However, Ext 3, para 2: Rising fuel costs Since cost of production is higher.
leads to a fall in the supply of air passenger
travel
SS - P and Q
Stand: (We want to show price indeed fall based on the case study)
Supply must increase as increased presence of low-cost carriers outweigh the increase in fuel
costs

Price

Final
stand
Increase
in
passenger
be more than
demand for it,
lower (extract 2,
prices)
and

S1

(1m):
supply of air
travel is likely to
S2
the increase in
hence price is
undercutting of
Fig 1: Market output
for airis higher.
passenger travel
(*not
necessary
for
students to draw dig for
D2 tutors to illustrate)

P
P1

D1
Q

(c)

Q1

Qty

Explain how the internet has affected the ability of the airlines to practice price
discrimination.
Note for tutors:
You may want to perform a life demonstration on buying an online air ticket and
showing live how airfares change within a short timeframe.
You can also show the class the article Airlines told to end price discrimination by
Stephen Castle

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[4]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Highlight to students that this question requires 2 points as answers can either be
for or against the increased ability to practice PD
From Extract 2, para 4,
Evidence from Data
airlines have a better idea of who their
customers are
more competitive market as consumers can
now compare prices more easily with the
Internet

State and Elaborate


This increases in ability to practice PD as it
enables the airlines to have better identification
of the market those whose demand is more
price-inelastic. E.g. last minute booking.
This decreases the airlines ability to practice
PD as better informed customers means harder
for airlines to charge different pricing and they
can turn to cheaper alternatives lesser
monopoly power.

2m for each point and max 3m for those who do not give 2-sided arguments

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Independent.co.uk
Airlines told to end price discrimination
By Stephen Castle Tuesday, 8 June 2004
Europe's airlines have been forced to end price differences of up to 300 per cent offered on the same flights in
different countries, after a six-month inquiry into their ticketing policies.
Europe's airlines have been forced to end price differences of up to 300 per cent offered on the same flights in
different countries, after a six-month inquiry into their ticketing policies.
The announcement came at the end of an investigation by the European Commission into the fares charged by 18
European airlines including British Airways, Air France, Lufthansa, SAS, British Midland, and Virgin Atlantic. BA
and SAS admitted having the different ticket charges but Giles Gantelet, spokesman for Loyola de Palacio, the EU
transport commissioner, said all airlines had now ended the practice. "A little bit of naming and shaming has
achieved results," he added.
One example discovered was of a return flight from Frankfurt to Berlin which cost 88 (59) when purchased in
Germany but 268 in Belgium. A 50 per cent differential was found in a flight between the UK and Germany.
Although the internet has revolutionised airline ticket sales, many companies still structure their systems so that
travellers have to use a website geared to their country of residence. As personal information and credit card
addresses have to be provided, and tickets often have to be mailed out, there is no opportunity to circumvent the
system by using a site belonging to the same company in another country. Similar factors have applied to
purchases made via travel agents or direct from airlines sales' offices.
However EU law means that companies are not allowed to discriminate between European customers on the
grounds of their place of residence.
Of the 18 airlines contacted by the commission, 16 responded, with most saying that they did not operate in this
way, and others saying they had stopped the practice. Italy's Alitalia said that, due to its current financial crisis, it
was unable to give a proper response and Olympic Airlines of Greece failed to reply.
However a test by the commission confirmed that all airlines had ended the practices. Mr Gantelet said: "In rare
cases some restrictions may still exist for certain paper-based tickets, but all electronic tickets are now available
throughout the EU without discrimination, except - in some cases - for differences in handling fees. As a result,
price levels are now similar for all EU residents." He added that the commission would continue to monitor the
airlines to make sure the problem does not return.
Steve Double, head of news at BA, said: "It is an issue which we were always comfortable with and we were
always confident of the outcome." Yesterday's announcement also marks a successful outcome for the
Commission, which might have had difficulty making a legal case stick.
The Commission's powers over airline prices are limited, although it could take action if it judged that there had
been a breach of EU treaty provisions, which lay down a level playing field for business within the internal market.

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

(d)

(i)

The Asia-Pacific airline industry has been described as oligopolistic. What evidence
in the data supports this?

[1]

Market share MCR4 has been greater than 60% over the past 2 years and thus show the presence
of a few dominant firms which is a characteristic of oligopoly.
Note to tutors:
Highlight to students, usually for a question on oligopoly, when a table with market share is
given and it is a MUST to calculate the Market Concentration ration rather then using other
information high barriers to entry which is true for monopoly or homogeneous product which
is also true for perfect competition or non-price competition which is true for monopolistic
competition..
Always give evidence that shows the unique characteristics (a few dominant firms and
mutual interdependence) of oligopoly.
Unless such unique characteristics are absent in the case material, then settle for the 2 nd
best answers such as high barriers to entry, etc which are still characteristics of oligopoly.
(ii)

Discuss how the firms in the airline industry might compete against each other and
how this might affect the society.

Note:
For such Higher Order Skills Question, use the following steps:
1. Come up with the economic framework.
2. Insert evidence from the data
There are two parts to the answers methods of competition and impact on society.
A 10 marks question warrants a proper introduction, body and conclusion.
A possible framework:
Competition in air-travel
Possible Methods of Competing
Price-cut by budget airlines
As there is price rigidity, airlines will engage in
Impact on society: Benefits or costs?
non price competition
Impact on society: Benefits or costs?
Conclusion: Which is more likely?
Introduction
I will be examining how the airlines might compete against each other in an oligopolistic industry and
how this might affect the society.
Body
Evidence from the extract includes:
Increase in contestability in the market (extract 2 deregulation of the airline industry)
Methods of competition:
1. Price-cutting by budget airlines as they offer no-frills service
2. Due to price-rigidity, there will be non-price competition by full-fledged carriers

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[10]

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

(1) Price-cutting by budget airlines as they offer no-frills service


State and Elaborate
Exemplify with Data/Contextual e.gs.
Reduce Price
Budget airlines have much lower costs compared
Budget/Low-cost airlines reduce airfare to to full-fledged carriers and thus translating the
raise revenue.
cost savings to lower prices. E.g. they can rent
planes instead of buying, buy commercial planes
Assuming demand is price elastic due to that are converted from military ones, land on
many airlines flying the same routes, a budget terminal, no-frills as they do not offer
lower airfare will increase quantity meals and in-flight entertainment, save on
demanded more than proportionate and middleman fee as booking are done directly at
thus increase revenue.
airlines via internet rather than agents
Evaluation:
Budget airlines are able to undercut prices as they have a different cost structure as compared
to full-fledged national carriers.
It is infeasible for national carriers to engage in a price war with the budget airlines. Even if they
cut airfare, it is at best a short-term measure. Also, such airfare cuts are only for a small number
of passengers and they serve as publicity gimmicks rather than genuine price cut and they come
with many hidden costs.
Impact on society (benefits):
Air travelers enjoy lower airfares and thus experience an increase in consumer surplus.
(2) Non-price competition by full-fledged carriers
Note: Before elaborating on non-price competition, it is critical to justify why there is no
price competition.

Airlines would choose to engage in non-price competition due to mutual


interdependence.
There are only a few airlines under oligopolistic market structure and thus each airline has to
take into account the actions/reactions of other firms and as a result, there is price
rigidity.
If an oligopolistic firm increases price, other firms will not follow and it will lose its consumers
to the competitors, and quantity demanded will fall more than proportionate leading to a loss
in revenue.
If it engages in a price competition by reducing price, other firms will probably respond by
reducing their prices as well and the quantity demanded will increase less than proportionate
and result in lower revenue.
Hence, airlines will more likely engage in non-price competition.

State and Elaborate


Product differentiation is done by airlines to
increase demand for their services and make
their demand more price-inelastic with
differentiated services.

Exemplify with Data


From Extract 3: Airlines attempted to provide
better service: Use internet for bookings
convenient and consumers can compare
prices across airlines.

Fly to more destinations


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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Own relevant knowledge: Better in-flight


services; frequent flights; advertising and
branding.
Impact on society (benefits):
Competition will lead to an increase in consumer welfare in terms of better airline products such
as travelling by shorter routes that save time, more frequent flights and better services by cabin
crew and in-flight entertainments. All these also encourage tourism and improve quality of life and
export revenue for the countries.
Impact on society (costs):

But if the non-price competition is in the form of persuasive advertising, the higher costs
may be translated to unnecessary increase in airfare.

Worsening market failure: If air-travelling indeed increase due to non-price competition


and other factors such as rising income, air pollution may worsen as mentioned in Extract 2,
para 1 that flying is 9 times worse than taking other modes of transport and in Extract 2, para
4 states that the passenger traffic grew by 11.8% in 2008 to reach a volume of 526.3 million
passengers.
Conclusion
Besides price and non-price competition, it is crucial for airlines to form alliances such as the
three major alliances -- Star, SkyTeam and oneworld which are global networks of carriers
that allow members to streamline costs while sharing revenue.
Overall, the society do benefit from these measures of competition in terms of cheaper
airfare and lesser carbon emission when airlines are able to cut costs by using technology
and fuel-efficient aircrafts and better services especially in terms of shorter routes and safety.
As long as the industry remains contestable, consumers will stand to benefit. Society
as a whole will gain in terms of higher export revenue in terms of tourism and more
jobs available.
L3
L2
L1
E1
E2

Good, balanced analysis based on the case material and good use of economic analysis
Explains the strategies of airlines using economics and with some references made to the case
material and mentions impact on society.
Describes strategies of airlines in a general manner (no/minimal use of economics) and with little
reference to case material; no or little mention of impact on society
Attempts to synthesise when there are conflicting views.
Provide good synthesis and a reasoned conclusion

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7-8
4-6
1-3
1
2

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Question 4 HCI Prelims 2007 Qn 1


SMRT and SBS Transit
Extract 1 Singapore MRT System
Singapore's mass rapid transit (MRT) system has been known for its reliability, efficiency and comfort.
It is run by two companies - Singapore MRT (SMRT) and SBS Transit. The 89.4-km North-South and
East-West Lines, operated by SMRT, began in 1987. The North-East Line (NEL) is one of the latest
additions to the MRT network. Opened in 2003, it is the first fully automated heavy rail lines in the
world and is operated by SBS Transit. The introduction of a second rail operator is an outcome
intended by the Singapore government to inject competition.
SMRT and SBS Transit have been adjusting their fares in recent years due to rising fuel price. Such
fare adjustments must be first approved by the Public Transport Council (PTC). As an independent
regulator of public transport fares, PTC is entrusted with the challenging mission of both safeguarding
the interest of the public and ensuring the long-term viability of public transport operators.
Table 1 Maximum Adult Fare per Ride (2004 2007)
2004

2005

2006

2007

SMRT

SBS

SMRT

SBS

SMRT

SBS

SMRT

SBS

$1.69

$1.69

$1.69

$1.69

$1.72

$1.72

$1.75

$1.75

Table 2 SMRT Fare Structure (by commuter category)


Fares
$0.66 $1.75
$0.65
$0.40 $0.50

Adult
Senior Citizen
Child & Student

Table 3 SMRT Fare Structure (by distance)


Distance travelled
Up to 3.2 km
3.21 km to 5.6 km
:
28.01 km to 30.0 km
Over 30.0 km

Fare per ride


$0.66
$0.88
:
$1.70
$1.75

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Extract 2 Derailment of Competition


There has been intense speculation of a merger between SBS Transit and SMRT. In its first year of
operation, the NEL incurred a loss of S$35 million as the housing estates along the NEL were
underdeveloped.
The potential of a deal between the transport operators was first floated by Transport Minister Yeo
Cheow Tong in 2003, when he said the Government would not object to a merger of rail operations.
With one company in charge he added, a lot of the overheads could be saved. He reiterated it soon
after, saying 'that competition for certain industries doesn't work in a small economy such as ours' and
that, commuters suffered in terms of higher NEL fares (up to 25 cents more than on other MRT lines)
and greater inconvenience. In the present set-up, commuters find they require more transfers to get to
their destinations because SBS Transit slashed too many of its bus services to avoid duplicating its
MRT services.
Transport analysts are shocked by the suggestion made by the Government. They do not see the
point, for either operator or commuters. According to them, the economies of scale would be limited
as the two rail systems are different and separated by 15 years of technological know-how. Moreover,
NEL commuters are also unlikely to benefit, because the higher fares are to make up for the higher
cost of running the fully automated line.
Source: Adapted from The Straits Times, September 2004 & October 2003
Extract 3 'Raility' Bites
Transport companies say the reality is that despite the privatised fronts, they are still obliged to run the
companies like statutory boards. They say their work is a tightrope walk between living up to privatesector performance indicators - in profit and productivity - and Singaporeans' sky-high service
expectations, and a public-service provider's responsibility to keep prices down to earth.
The fact that both SMRT and SBS Transit are publicly listed companies adds a thorny third dimension.
'As any business textbook will tell you, shareholders come first; or else, there will be a lot of yelling
come the annual general meeting,' says a senior industry source. This is worsened by the fact that
transport costs remain a flaming-hot political potato. A five-cent fare hike can translate into public
outrage and lost votes at election time.

Source: The Straits Times, November 10th 2003

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Figure 1 Affordability Trend for a Typical Family in Singapore

Source: PTC Report, May 2005


(a)

(i)

Summarise the changes in the maximum adult fare per ride charged by SMRT and
SBS Transit from 2004 to 2007.

[2]

(ii)

Using the information provided, account for the above changes.

[2]

(iii
)

Explain why pricing policies by SMRT are examples of price discrimination.

[4]

(b)

With the aid of a diagram, explain the losses incurred by SBS Transit from operating the
North-East Line in 2003.

[4]

(c)

(i)

How far does the data suggest that the level of competition is raised in the MRT
system?

[2]

(ii)

The transport analysts were skeptical about the potential benefits of a merger between
SMRT and SBS Transit as the 'economies of scale would be limited'.

[6]

To what extent do you agree with the above view?

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

(a) (i) Summarise the changes in the maximum adult fare per ride charged by SMRT and SBS Transit
from 2004 to 2007. [2]
Table 1 Maximum Adult Fare per Ride (2004 2007)
2004

2005

2006

2007

SMRT

SBS

SMRT

SBS

SMRT

SBS

SMRT

SBS

$1.69

$1.69

$1.69

$1.69

$1.72

$1.72

$1.75

$1.75

With reference to Table 1:


Increasing [1m]
Increment of 3 cents/low increment/modest rise [1m]
(ii) Using the information provided, account for the above changes. [2]
Rising trend - Higher fuel price [1m]
Low increment - Government (PTC) regulation [1m]
Public transport (in this case, MRT) is a merit good
Infrastructure make it accessible for all
(iii) Explain why pricing policies by SMRT are examples of price discrimination. [4]
Table 2 SMRT Fare Structure (by commuter category)
Fares
$0.66 $1.75
$0.65
$0.40 $0.50

Adult
Senior Citizen
Child & Student

With reference to Table 2: Higher fare for adults and concessionary rates for elderly, children and students.
Adults are charged a higher price given that their demand is relatively price inelastic (the fares would
constitute a small proportion of their income.
This is an e.g. of 3rd degree PD. [2m]
Table 3 SMRT Fare Structure (by distance)
Fare per ride
Fare per km
$0.66
$0.21
$0.88
$0.09
:
As distance (km), the fare charged per
$1.70
distance.
$1.75

Distance travelled
Up to 3.2 km
3.21 km to 5.6 km
:
28.01 km to 30.0 km
Over 30.0 km

With reference to Table 3: Passengers travelling on longer distances (or larger 'blocks') incur a lower fare
per kilometre.
This is an e.g. of 2nd degree PD. [2m]

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

(b) With the aid of a diagram, explain the losses incurred by SBS Transit from operating the North-East
Line in 2003. [4]

SBS Transit "natural monopoly" over the NEL given the huge fixed / start-up cost, the firm's AC and
MC curves will be continuously falling over the entire range of output. [1m]
At profit maximising output level Q E, AC > AR subnormal profit / loss (represented by Area ABCP E)
incurred by SBS Transit. Low demand due to low occupancy rate of the HDB flats along NEL less
passengers. [1m]
Costs/Rev/Price

A
PE

C
AC
MC
MR

AR=DD
Qty

QE

2m for correct diagram but no penalty for drawing a U-shaped AC & MC as penalty will be given for wrong
explanation.
Students can also draw normal monopoly diagram as the infrastructure is actually built by LTA, not the rail
operator.
(c) (i) How far does the data suggest that the level of competition is raised in the MRT system? [2]

On the one hand, the objective appears to have been met as the rail industry has now 2 players SMRT
and SBS Transit OR there is improvement in quality of service fully automated train services by NEL. [1m]
However, one must bear in mind that SMRT runs N-S Line and E-W Line; while SBS Transit N-E Line (from
Extract 1) each operates systems that are independent of each other as they cater to different regions of
Singapore two mutually exclusive monopolies. [1m]

(ii) The transport analysts were skeptical about the potential benefits of a merger between SMRT and
SBS Transit as the 'economies of scale would be limited'. To what extent do you agree with the
above view? [6]
Statement with Elaboration and Exemplification
Rail industry huge capital outlay Substantial internal (technical) EOS thus with a merger, the
combined company is able to further spread the sunk cost as it would be producing at a greater scale
enjoys lower per unit cost.

However, this is based on the implicit assumption that the technologies on which the N-S & E-W lines and
NEL are the same, which in fact are not (Extract 2 Para 3). Also, they operate different routes so strictly
speaking not the same kind of service.

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

While a merger would allow the firm to enjoy various other types of internal EOS (marketing, administrative
and risk-bearing apply to context), the cost savings that can be derived from these EOS is limited.
Conclusion:
Hence a merger between SMRT and SBS Transit would bear little cost advantages.

L3
L2
L1

Good explanation and application on why technical EOS may not be a good reason for
lowering costs and how cost savings are indeed minimal.
Explained EOS with some reference to context.
Explained EOS with no/little reference to context.

5-6
3-4
1-2

(d) "When market dominance exists, consumer exploitation is inevitable" Discuss whether the data
supports this view. [10]
Introduction
Market dominance may lead to the exploitation of consumers because of the higher price they pay and the lower
quantity which is transacted on the market.
However, firms with market dominance may also enjoy economies of scale which may benefit consumers in the
form of lower prices and better quality products in the light of competition for greater market share which entices the
firms to engage in R&D.
Body
Thesis: Consumer exploitation inevitable

Anti Thesis: Consumer exploitation not inevitable

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HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

Monopoly power means higher fares loss


of consumer surplus.
Costs/Rev/Price

PMC
A
PPC

B
C

AC
MC
E

MR

AR=DD

Q
Qty
PMC > PPC
E
Loss of consumer
surplus = area DEPPCA

Students can also draw normal monopoly


diagram as the infrastructure is actually built by
LTA, not the rail operator.

Although there is a rising trend for fare based on Table 1, it


is due to higher fuel costs and may not be due to market
dominance.
Furthermore, any fare adjustments must be approved by
PTC, ensuring that the interest of the public is safeguarded
3 cents increment annually.
SMRT and SBS Transit are subjected to regulation (PTC) as
public transport is regarded as a merit good.
Thus even though fares have indeed increased, the
changes were minimal at 3 cents.
Political reason: A five-cent hike can translate into public
rage and lost votes at election time (alternative objective to
profit maximization).
Refer to Figure 1: Affordability trends downward Increase
in fares wouldn't hurt the consumer pockets given public
transport expenses accounts for a small proportion of a
typical household's income (2004 5%)

Evaluation: However, it can be argued that any fare increase,


no matter how small, will have some impact on the consumers,
especially on the lower-income group who depends heavily on
public transportation to get around the island. Fig 1 only shows
the % of expenditure on public transport for a typical family. The
weighting is definitely higher for lower income group.
Note: Also with growing affluence, households may have
switched towards alternative modes of transportation such
as taxis.
-

The higher fares charged on NEL are justified due to the


higher cost incurred.

Note: Evidence from LTA's survey findings says otherwise


> 80% of the general public were satisfied with the
service standards; as well as SMRT's $145 million project to
upgrade its trains.

A case in pt is the higher NEL fares as


well as inconvenience imposed on
commuters as they are left with no /
little choice due to the removal of
substitute buses.

The rail operators may be complacent


and lack incentive to minimise cost.
Service standards may also be
compromised (e.g. waiting time)

Substitute buses were removed to avoid duplication of


resources rationalisation/streamlining of services to
minimum cost minimize wastage of resources.

Being a publicly listed, SMRT and SMS Transit have to


live up to private-sector performance indicators profits
and productivity Singaporeans sky-high service
expectations this implies they have to constantly
upgrade their train and services.

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42

HWA CHONG INSTITUTION


Year Two H2 Economics 2014
Chapter #23: Microeconomics III Theory of the Firm & Market Structure

3rd PD Raise producer surplus at the


expense of consumer surplus

By practicing 3rd PD, it is possible to supply extra


markets.
Higher profits earned from one market (Adults) could
help in offsetting the lower profits from others (Senior
citizen and Student & Child).

Conclusion
The level of market dominance influences the conduct of firms in the industry. Although a larger degree of market
power may lead to the exploitation of consumers, there are also instances when more market power might actually
be beneficial instead.
Furthermore, given various government regulators and competition law present, SMRT and SBS Transit would be
less able to engage in activities that would exploit the consumers.
L3
L2
L1
E2
E1

Excellent explanation of concepts and well supported with relevant evidences; balanced view with
conclusion.
Applied to context but lopsided view
Explained why market dominance is bad for consumers with no/little reference to context.
OR
Purely lifting evidences from the passage without link to economic concepts.
Judgment based on analysis (justified conclusion)
Mainly unexplained judgments

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43

7-8
4-6
1-3
2
1

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