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Edexcel Advanced GCE Economics

9121 Unit 4 (6354)

Further Exemplar Questions

Time: 1 hour 15 minutes

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Section A

In this section there are 10 multiple choice questions.

For each question there are five suggested answers; A, B,C, D and E. When you have selected your
answer to the question, write the chosen letter against the number of the question in your script.

You can only offer one answer to each question.

After making your selection you should justify your choice with an explanation. Where appropriate,
you are encouraged to use diagrams as part of your explanation in the space provided.

You will score one mark for each correct answer and a maximum of three marks for each
justification of your answer.

You are advised to spend approximately 30 minutes on this section.

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1) The Competition Commission report on the proposed merger between BSkyB and
Manchester United football club expressed concern that the merger, if it took place, would
strengthen BSkyB’s position as a “vertically integrated broadcaster”. This means that BskyB:

A) Owns a number of other broadcasting companies around the world

B) Has many business interests unrelated to broadcasting

C) Can reduce the money it has to spend on advertising

D) Makes and distributes programmes to customers

E) Is already a natural monopoly

Answer (1 mark)

Explanation ………………………………………………………………………….

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(3 marks)

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2) The licences of water companies in the UK provide that in any year they may not increase
their prices by more than RPI + K where K may be positive, negative or zero. The Director of
OFWAT set a value for K of –17% for the Sutton and East Surrey Water PLC for the period
April 2000 to April 2001. This suggests that:

A) The water company would inevitably be loss making during this period

B) The water company’s prices will be 17% below marginal costs

C) The company’s share price will rise in nominal terms

D) The company’s water prices are likely to rise in real terms

E) The director of OFWAT believes there is room for the water company to make
efficiency improvements

Answer (1 mark)

Explanation ………………………………………………………………………….

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(3 marks)

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3) The diagram shows the revenue and cost position of a monopoly:

Price
per
unit
MR AR MC

AC

V W X Y Z
Quantity
Which of the following statements is true?

A) The firm would maximize its revenue at X

B) The firm would be allocatively efficient at V

C) At output W the firm would make a loss

D) At output Z the firm would have zero costs

E) At output Y the firm would be technically efficient

Answer (1 mark)

Explanation ………………………………………………………………………….

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(3 marks)

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4) In 1993, ICI demerged its bioscience businesses of pharmaceuticals, agrochemicals, seeds and
biological products into a separate, publicly listed company, Zeneca Group PLC. One reason
for doing this might have been that ICI was facing:

A) Monopolistic competition

B) Supernormal profits

C) Limit pricing

D) A perfectly contestable market

E) Diseconomies of scale

Answer (1 mark)

Explanation ………………………………………………………………………….

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(3 marks)

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5) Assume that a monopoly produces a profit maximising level of output. Which of the
following statements is true for such a firm?

A) At the profit maximizing level of output marginal profit will be positive

B) At the profit maximizing level of output marginal revenue equals zero

C) At the profit maximizing level of output the price elasticity of demand will be greater
than one

D) The firm will necessarily be making supernormal profits

E) Raising output will reduce the firm’s revenue

Answer (1 mark)

Explanation ………………………………………………………………………….

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(3 marks)

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6) A regulatory agency is less likely to be concerned that a firm has a large market share if it
believes that

A) There is every prospect that the firm will be able to increase its share further

B) There is good evidence of limit pricing

C) The firm is making high levels of supernormal profits

D) The firm’s advertising expenditure is very high

E) The market is contestable

Answer (1 mark)

Explanation ………………………………………………………………………….

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(3 marks)

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7) Which of the following markets is closest to the model of monopolistic competition?

A) The UK airline industry

B) The market for branded trainers

C) The market for petrol

D Hair dressers who engage in local advertising

E) The wholesale commodity market for coffee

Answer (1 mark)

Explanation ………………………………………………………………………….

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(3 marks)

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8) A monopoly changing from a policy of profit maximization to one of revenue maximization
will now be operating at

A) A higher level of output and higher marginal costs

B) A higher level of output and higher marginal revenue

C) A lower level of output and lower marginal costs

D) A lower level of output and lower marginal revenue

E) A lower level of output but with marginal cost equal to marginal revenue

Answer (1 mark)

Explanation ………………………………………………………………………….

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(3 marks)

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Section B

Answer EITHER Question 11 OR Question 12 from this section

(You should spend approximately 40 minutes on this section)

11. British Telecom

Extract 1

“It was a dismal quarter at the end of a dismal year for investors in British
Telecommunications. The shares fell 62.2 per cent over 2000, the second worst
performance in the Financial Times top 100 companies share index. At the start of the
year, the company was seen as a potential winner from the dotcom revolution, as
5 investors logged on to the net using BT’s lines; by mid-year the group was seen as a
lumbering giant, saddled with too much debt.

In November, the company tried to counter this image by announcing a demerger that
will lead to BT becoming five separate companies. The plan is to float off 25 per cent
of the group’s mobile phone assets later this year. There will also be flotations of the
10 business services and “Yellow Pages” divisions – BT’s profitable directory of
commercial phone numbers. A new company will also be formed to own the UK
network infrastructure.

BT is generally seen to have been overtaken by rivals such as Vodafone, and to have
failed with its international strategy. It was also criticised for not doing enough to open
15 up its local network to competition.”

(Source: Financial Times 27th January 2001)

Table 1

Oftel: BT Price Controls


(low to medium spending residential customers)

1993 – 1997 RPI – 7.5%


1997 – 2001 RPI – 4.5%
2001 - No Price Control Planned

(Source: http://www.oftel.co.uk/history.htm)

Extract 2

“Internet users pay more for high-speed access in Britain than in other leading
industrialised countries research commissioned by Oftel, the telecommunications
watchdog, says.

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The independent survey undermines previous claims by Oftel that Britain has not
5 slipped behind in the provision of so-called broadband access.

Researchers compared prices in the US, France and Germany and found that the
average monthly charge for residential broadband services was highest in the UK at
about £40. This compared with £32 in Germany, which has been faster at allowing
competing operators to develop broadband technology for fast internet access. New
10 technology makes possible the use of the existing infrastructure by many firms by
enabling phone lines to carry 50 times more data. The process of allowing the entry of
new competitors to establish their own broadband services by connecting to BT’s
existing copper wire network at local telephone exchanges is known as ‘local loop
unbundling’. The idea is to allow rival firms to use BT’s existing lines for services
15 such as high speed internet access.

The unbundling process in the UK has fallen behind other European countries, with
just 2 per cent of BT’s exchanges currently open to competitors compared with 100
per cent in Germany. BT is also slower in offering its own broadband services: it now
has 15,000 lines connected compared with 300,000 in Germany. BT has been accused
20 of denying access to some of the exchanges rival companies most want.”

(Adapted from: The Financial Times 27th January 2001)

(a) (i) Explain the meaning of BT’s current price control formula of
“RPI – 4.5%” in table 1. (4 marks)

(ii) Why might the regulator have changed the price formula from its previous rate of
“RPI – 7.5%” ? (4 marks)

(iii) Discuss one advantage and one disadvantage of having price control periods as long
as five years (8 marks)

(b) Examine the likely economic consequences of a lack of progress in local loop unbundling
(extract 2, line 15). (10 marks)

(c) Give one reason why a regulator such as Oftel may be ineffective (4 marks)

(d) To what extent are the suggested de-merged companies for Yellow Pages and ownership of
the network infrastructure (extract 1, lines 11-13) likely to form contestable markets?
(10 marks)

(Total marks for Question 11: 40 marks)

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12. CD Pricing

Extract 3

“The European Commission has launched an investigation into alleged price-fixing of


CDs by music companies, a spokeswoman confirmed yesterday. The Commission is
concerned about the high price of CDs in the EU market compared with the US.

‘We are looking into the so-called contracts between the largest record companies and
5 retailers to see if there is a policy of maintaining retail prices,’ said Amelia Torres,
Commission spokeswoman. The big record companies agreed last May to drop a
policy which required retailers to display a minimum price for CDs in their
advertisements.

The UK Consumers’ Association also made a statement, confirming that it had been
10 concerned about high-priced CDs for many years. The organisation pointed to moves
by record companies to release UK-only versions of top CDs to stop retailers such as
J. Sainsbury from importing lower priced CDs from other EU countries to sell at
£9.99.

‘They killed the imports overnight’ an official said, ‘it’s clearly an attempt to partition
15 the market’.

(Adapted from: The Financial Times 27th January 2001)

Table 2

International Britney Spears U2


CD “Oops I did it “All That You Can’t
Pricing Again” Leave Behind”
UK £14.16 £12.99
Europe £11.82 £12.88
USA £10.77 £10.63

(Adapted from: The Evening Standard, 19th February 2001)

Extract 4

“The Office of Fair Trading is investigating whether seven of the world’s largest
record companies are guilty of price-fixing. It has launched a six-month inquiry into
Sony, Universal Music UK, EMI, Bertelsmann Music, Warner Music, Virgin and
Pinnacle – Britain’s largest independent record distributor.

5 The OFT says it has ‘reasonable grounds for suspecting’ that they have conspired to
stop retailers from importing cheaper compact discs from Europe.
Massive penalties face any record label found guilty of breaching the 1998
Competition Act: up to a tenth of their British turnover for every year of the
infringement, up to a maximum of three years. The Act prohibits cartels, “concerted
10 practices” and abuse of a dominant position.

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(Adapted from The Evening Standard, 19th February 2001)

(a) Which market structure best describes the UK CD industry? Justify your choice.
(4 marks)

(b) If all firms in the CD industry use cost plus pricing, how might the data in table 2 be
explained? (6 marks)

(c) Suppose that, in fact, the directors responsible for USA record sales are pursuing sales
maximising objectives whilst those with responsibilities for the UK pursue profit maximising
objectives. On this assumption, and making use of a diagram, explain the data in table 2.
(10 marks)

(d) (i) Explain the term ‘cartel’ (extract 4, line 9) (4 marks)

(ii) Why might it be advantageous for firms in the CD industry to engage in collusive
behaviour?
(6 marks)

(e) Evaluate the likely economic benefits of implementing competition policy, such as that
contained in the 1998 Competition Act (extract 4, line 7), in the CD industry.

(10 marks)

(Total marks for Question 12: 40 marks)

(Total marks for Unit 4: 80 marks)

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Mark Scheme Unit 4

Question Scheme Marks

(1) D 1

BSkyB is a TV programme distributor but also a programme maker.


Purchasing Manchester United football club would give it stronger links
with the production of a major part of its business – the broadcasting of
sports events. This is an example of backwards vertical integration:
purchasing a company at an earlier stage of production than itself. A
maximum of 2 marks if a definition only, is given. For full marks there
must be reference to BskyB. 3

(2) E 1

Candidates need to explain that the RPI is a measure of inflation (or the
cost of living) (1 mark) and that the regulator has decided to limit price
increases to the rate of inflation less 17%. This will mean real price
reductions for SESW (1 mark) The standard assumption is that rigorous
price interventions of this kind are intended as a surrogate for competition
– on the premise that there potential efficiency improvements. (1 mark) 3

(3) A 1

A firm maximizes its revenue where marginal revenue is equal to zero, i.e.
where adding one more unit of output adds nothing further to revenue. (2
marks) To the left of C, MR is positive – each unit adds to revenue, to the
right of C, MR is negative – revenue will be falling as output increases. (1 3
mark)

(4) E 1

Diseconomies of scale involve rising long run average costs. (1 mark) ICI
may have been experiencing problems co-ordinating the various aspects of
its business in terms of lines of control, delays in making decisions,
consistency of decisions across the company. Diseconomies of scale may 3
have led it to reduce the operating size of each business unit. (2 marks)

(5) C 1

Profit maximization takes place where marginal revenue equals marginal


cost, i.e. where marginal profit equals zero. (1 mark) Since firms have
positive marginal costs, the profit maximizing position must feature
positive marginal revenue. This implies that profit maximizing monopolies
will reduce output to drive up the price so as to operate on the top half of
the demand curve, where PED > 1. (2 marks)
3

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(6) E 1

A contestable market is one where there are low barriers to entry and exit,
(1 mark) i.e. where there are low sunk costs. (1 mark) This allows hit and
run competition; the threat of this may be enough to force a firm with large
market share to act as if it is in competition, so requiring less regulation. (1
mark) 3

(7) D 1

There are many buyers and many (independent) sellers in the hair dressing
industry. (1 mark) There is good (local) information about prices and low
barriers to entry. (1 mark) However, the market is characterized by local
advertising: the resulting local brand loyalty means that each firm faces a
less than perfectly elastic demand curve: monopolistic competition. (1
mark) 3

(8) A 1

Candidates will probably find it easiest to answer this question by using a


diagram. At the profit maximizing level of output MR=MC which implies
(since MC > 0) that MR is positive. This allows the firm to raise revenue
by raising output. Marginal costs will then tend to rise (but explicit
reference to diminishing marginal returns is not required.) 3

(9) B 1

Some indication of the definition of perfect competition. (1 mark) The low


barriers to entry allow any supernormal profits to be competed away. (1
mark) Definition of allocative efficiency: the price taking firm will reduce
its price to the bottom of the AC curve (only normal profit) where AC =
MC. Thus price will be set equal to marginal cost. (1 mark) 3

(10) D 1

Candidates must specify the conditions of successful price discrimination


(1 mark) but applied specifically to medical treatment (2 marks). Thus
surgeons may be able to identify different groups of customers with
different elasticities of demand (e.g. by the car they drive), and operations
are not tradable second hand – so ruling out second hand arbitrage. An
optional point might include the information failure that tends to make
patients treat the specialist recommended by their GP as monopolist
suppliers of good health. 3

Total Marks: 40

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Q. 11

Section Scheme Marks

(a) (i) BT is regulated according to the RPI – X formula. Here X has been set at
4.5%. This allows BT to raise their average price in any one year by no more
than the rate of inflation less 4.5%. This has meant real (and nominal) price
cuts in BT’s services to residential customers. 4

(a) (ii) The price formula in the early 1990s was quite aggressive: it is likely that
Oftel felt that there was less room for efficiency improvements in the current
price round, for example, BT had already shed a great deal of labour.
4
Advantages: e.g. gives the company time to reap the reward of efficiency
(a) (iii) improvements in excess of those demanded by the pricing formula. If the
price formula was set annually there would be no profit incentive to beat
these efficiency targets. Also award arguments such as stability of
investment decision making, planning etc (4 marks).

Disadvantages: five years might be thought to be too long for a single


formula to accurately reflect changes in BT’s market conditions. If these
change markedly, or if the regulator was misinformed in the first place, then
BT may be able to make supernormal profits for an extended period of time.
Also award arguments based on too harsh a formula. (4 marks).

Award any relevant analysis. However, for level 5 marks there must be a 8
significant degree of evaluation. An obvious (but not essential) division of
(b) argument would be micro and macro consequences:

Micro: if BT does not grant access to its local loops then it will gain market
power as the demand for high bandwidth access increases. This will allow it
to continue to charge high prices (resulting loss of consumer surplus,
allocative inefficiency, welfare loss.) There will also be a narrowing of
consumer choice of broadband services. However, the lack of interest in
unbundling by other telecommunication suppliers may suggest there are
significant economies of scale here. These might be lost through unbundling
leaving consumers with higher prices. (6 marks)

Macro: cheap broadband internet access may be a key supply side feature of
the UK economy. If access prices in the UK remain higher than those in, say,
Germany, then UK firms will face a competitive disadvantage. However, this
may be of minor significance in the context of other supply side issues. (4
marks)
Award any of the following, but full marks only if they are properly
explained: asymmetry of information, complexity of the telecoms industry,
regulatory capture. 10
(c)
Definition of contestability in terms of low barriers to entry and exit,
particularly low sunk costs. Potential for hit and run competition. (2 marks). 4
Assessment must consider “to what extent” for level 5:
(d)
Assessment of contestability of Yellow Pages. There are already some rivals
in this market (particularly local directories) suggesting that barriers to entry
are not insurmountable. However, Yellow Pages is a famous brand so there
would be significant (sunk) advertising costs for a new entrant. Getting hold

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of the required information may also be an irretrievable expense. (4 marks).

Assessment of Network Infrastructure Company. This seems more


straightforwardly to be unlikely to be contestable. Laying competing
telephone lines is likely to be seen as prohibitively expensive by new
entrants. However, what about alternative technologies, such as satellite and
cable transmission? (4 marks)

10

Oligopoly (2 marks). There are a few large, interdependent firms suspected


Q12 of using market power (2 marks).

Definition of cost plus pricing – prices set by adding a constant mark-up to


(a) average costs. (2 marks) The data could then be explained in terms of
differences in average costs supplying CDs to different countries. E.g. 4
differences in transports costs or, if the CDs are made locally, differences in
(b) production costs (land, capital or labour costs). (4 marks) Also, allow an
explanation in terms of differences in standard mark-ups by directors
responsible for different countries.

Clear definition of sales maximization in terms of the maximum level of


output which can be produced without making a loss, ie, where AR=AC (2
marks) and profit maximization in terms of MR=MC (2 marks). 6
Appropriate diagram illustrating these two levels of output (3 marks).
(c) Explanation of resulting difference in prices, related to the data in the table
(3 marks).

Definition of cartel: formal, contracted, collusive agreements between


producers. (2 marks) Illustration – e.g. OPEC (2 marks).
10

(d)(i) Some analysis of the advantages of oligopolistic collusion. i.e. that the firms
involved can act as if a monopoly and thus gain supernormal profits 4
(supported with an appropriate diagram). Alternatively, some analysis of the
price-setting dilemmas of oligopolists, illustrated, for example, with a simple
(d)(ii) prisoners’ dilemma. Alternatively, the kinked demand curve will no doubt
make several appearances. (6 marks)

Effects on both consumers (5 marks) and producers (5 marks) should be


considered. The discussion of consumers should refer to consumer surplus
and choice. The discussion of producers to price, output, profit and 6
efficiency. Appropriate diagrams will add value. No detailed knowledge of
(e) the Competition Acts is required but candidates may draw on the passage.

For a level 5 mark answers must contain a significant level of evaluation.


This might include acknowledgement of the information problems of
implementing competition policy, the potential for lost economies of scale,
the potential damage to investment decision making if fines are imposed etc.
This may also impact on consumers in terms of reduced choice if too much
uncertainty is created.

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10

Exemplar Questions Unit 3

Mark Scheme Unit 3 (Essays)

1.

Question Scheme Marks


(a) Understanding “nominal” in terms of cash value, or monetary value. (1
mark) Definition of GDP in terms of value of goods and services
produced in the UK. (1 mark). Understanding “real GDP” (volume
measure of goods and services produced in the UK). Also accept
variants on “value of goods after the rate of inflation has been taken
out.” (3 marks) 5

(b) (i) A depreciation of sterling, other things remaining the same, reduces
the price of UK exports and raises the sterling price of UK imports. (1
mark). This will tend to raise aggregate demand (1 mark). Illustration
of this on an AD/AS diagram (1 mark). [Alternatively, candidates
may discuss shifts in the AS curve caused by increased imported input
costs.] Resulting multiplied expansion in real output (1 mark). Some
critical distance: e.g. import/export elasticities or real wage resistance
or crowding out (1 mark).
5
A rise in UK interest rates will tend to reduce aggregate demand.
(b) (ii) Identification of transmission to consumption, investment and the
exchange rate (2 marks). Illustration on AD/AS diagram (1 mark)
[Alternatively, there may be a longer-term influence on AS.]
Consequences for growth in an AD/AS (or more descriptive)
framework (2 marks).
5
Award either an in depth appraisal of (for level 5 at least two) other
(c) macroeconomic goals, or a broad ranging approach that looks at a
number of different alternative goals.

Other goals mentioned in the syllabus include: full employment, price


stability, Balance of Payments equilibrium, income redistribution, and
concern for the environment. There needs to be some consideration of
the likely trade-off between high growth and other goals, e.g. a Phillips
curve relationship with inflation.

For a level 5 answer, candidates must spend some time evaluating


their points in the form of “ifs and buts” about the form of the trade-
off, that other things may not be equal, that there are uncertainties
involved.

Total Mark for Question 1: 30 15

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2. The balance of payments records transactions in sterling on the foreign
exchange market (there are a number of allowable ways of putting
this) (1 mark). Main subsections of the current account need to be
(a) identified: trade in goods, trade in services, investment income and
current transfers (3 marks). A surplus means that purchases of sterling
for those reasons exceed sales of sterling. (1 mark).

A fall in the standard rate of income tax will raise household


disposable income. This will raise consumption (1 mark). Investment
incentives may raise the level of investment, further raising aggregate 5
demand (1 mark) Investment will, in the longer term, also raise
(b) (i) aggregate supply (1 mark). Illustration of this on AD/AS diagram
raising the equilibrium level of income (1 mark). Reference to
multiplied expansion from the increase in AD (1 mark).

Some of the (multiplied) increase in incomes will leak into imports


through consumption of foreign goods. (1 mark) Some extra
investment goods may also be imported. (1 mark) The extra
investment may make UK exports/ import substitutes more 5
competitive in the longer term (2 marks) or effects of budget policies
(b) (ii) on current a/c via inflation and export/import prices (2 marks) Some
assessment of the likely overall effect e.g. in terms of short run/long
run or of the significance of elasticities (1 mark).

Analysis of impact of higher interest rates on aggregate demand,


specifying the likely transmission through consumption, investment
and the exchange rate (5 marks). Putting this in an AD/AS framework
to show the reduced pressure on the price level (accept falling AD,
reducing the price level) (3 marks). Some “ifs and buts” about the 5
lags/potential lack of response to the rate rise (2 marks).
(c)
Discussion of the consistency of this policy with maintaining a surplus
on current account. Reducing (the rate of growth of) real incomes
should reduce imports. Much will depend on the elasticities. (3 marks
). Meanwhile, reduced inflation in the UK should increase
international competitiveness, other things remaining the same. (2
marks).

Total Mark for Question 2: 30

15

Exemplar Questions Unit 4

Mark Scheme Unit 4

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Question Scheme Marks

(1) D 1

BSkyB is a TV programme distributor but also a programme maker.


Purchasing Manchester United football club would give it stronger links
with the production of a major part of its business – the broadcasting of
sports events. This is an example of backwards vertical integration:
purchasing a company at an earlier stage of production than itself. A
maximum of 2 marks if a definition only, is given. For full marks there
must be reference to BskyB. 3

(2) E 1

Candidates need to explain that the RPI is a measure of inflation (or the
cost of living) (1 mark) and that the regulator has decided to limit price
increases to the rate of inflation less 17%. This will mean real price
reductions for SESW (1 mark) The standard assumption is that rigorous
price interventions of this kind are intended as a surrogate for competition
– on the premise that there potential efficiency improvements. (1 mark)
3
A
(3) 1
A firm maximizes its revenue where marginal revenue is equal to zero, i.e.
where adding one more unit of output adds nothing further to revenue. (2
marks) To the left of C, MR is positive – each unit adds to revenue, to the
right of C, MR is negative – revenue will be falling as output increases. (1
mark)
3
E
(4) 1
Diseconomies of scale involve rising long run average costs. (1 mark) ICI
may have been experiencing problems co-ordinating the various aspects of
its business in terms of lines of control, delays in making decisions,
consistency of decisions across the company. Diseconomies of scale may
have led it to reduce the operating size of each business unit. (2 marks)

(5) Profit maximization takes place where marginal revenue equals marginal 1
cost, i.e. where marginal profit equals zero. (1 mark) Since firms have
positive marginal costs, the profit maximizing position must feature
positive marginal revenue. This implies that profit maximizing monopolies
will reduce output to drive up the price so as to operate on the top half of
the demand curve, where PED > 1. (2 marks)

E
3

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A contestable market is one where there are low barriers to entry and exit,
(6) (1 mark) i.e. where there are low sunk costs. (1 mark) This allows hit and 1
run competition; the threat of this may be enough to force a firm with large
market share to act as if it is in competition, so requiring less regulation. (1
mark)

D
3
There are many buyers and many (independent) sellers in the hair dressing
(7) industry. (1 mark) There is good (local) information about prices and low 1
barriers to entry. (1 mark) However, the market is characterized by local
advertising: the resulting local brand loyalty means that each firm faces a
less than perfectly elastic demand curve: monopolistic competition. (1
mark)

A
3
Candidates will probably find it easiest to answer this question by using a
(8) diagram. At the profit maximizing level of output MR=MC which implies 1
(since MC > 0) that MR is positive. This allows the firm to raise revenue
by raising output. Marginal costs will then tend to rise (but explicit
reference to diminishing marginal returns is not required.)

Some indication of the definition of perfect competition. (1 mark) The low 3


barriers to entry allow any supernormal profits to be competed away. (1
(9) mark) Definition of allocative efficiency: the price taking firm will reduce 1
its price to the bottom of the AC curve (only normal profit) where AC =
MC. Thus price will be set equal to marginal cost. (1 mark)

Candidates must specify the conditions of successful price discrimination


(1 mark) but applied specifically to medical treatment (2 marks). Thus 3
surgeons may be able to identify different groups of customers with
(10) different elasticities of demand (e.g. by the car they drive), and operations 1
are not tradable second hand – so ruling out second hand arbitrage. An
optional point might include the information failure that tends to make
patients treat the specialist recommended by their GP as monopolist
suppliers of good health.

Total Marks: 40

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Q. 11

Section Scheme Marks

(a) (i) BT is regulated according to the RPI – X formula. Here X has been set at
4.5%. This allows BT to raise their average price in any one year by no more
than the rate of inflation less 4.5%. This has meant real (and nominal) price
cuts in BT’s services to residential customers. 4

(a) (ii) The price formula in the early 1990s was quite aggressive: it is likely that
Oftel felt that there was less room for efficiency improvements in the current
price round, for example, BT had already shed a great deal of labour.
4
Advantages: e.g. gives the company time to reap the reward of efficiency
(a) (iii) improvements in excess of those demanded by the pricing formula. If the
price formula was set annually there would be no profit incentive to beat
these efficiency targets. Also award arguments such as stability of
investment decision making, planning etc (4 marks).

Disadvantages: five years might be thought to be too long for a single


formula to accurately reflect changes in BT’s market conditions. If these
change markedly, or if the regulator was misinformed in the first place, then
BT may be able to make supernormal profits for an extended period of time.
Also award arguments based on too harsh a formula. (4 marks).

Award any relevant analysis. However, for level 5 marks there must be a 8
significant degree of evaluation. An obvious (but not essential) division of
(b) argument would be micro and macro consequences:

Micro: if BT does not grant access to its local loops then it will gain market
power as the demand for high bandwidth access increases. This will allow it
to continue to charge high prices (resulting loss of consumer surplus,
allocative inefficiency, welfare loss.) There will also be a narrowing of
consumer choice of broadband services. However, the lack of interest in
unbundling by other telecommunication suppliers may suggest there are
significant economies of scale here. These might be lost through unbundling
leaving consumers with higher prices. (6 marks)

Macro: cheap broadband internet access may be a key supply side feature of
the UK economy. If access prices in the UK remain higher than those in, say,
Germany, then UK firms will face a competitive disadvantage. However, this
may be of minor significance in the context of other supply side issues. (4
marks)
Award any of the following, but full marks only if they are properly
explained: asymmetry of information, complexity of the telecoms industry,
regulatory capture. 10
(c)
Definition of contestability in terms of low barriers to entry and exit,
particularly low sunk costs. Potential for hit and run competition. (2 marks). 4
Assessment must consider “to what extent” for level 5:
(d)
Assessment of contestability of Yellow Pages. There are already some rivals
in this market (particularly local directories) suggesting that barriers to entry
are not insurmountable. However, Yellow Pages is a famous brand so there
would be significant (sunk) advertising costs for a new entrant. Getting hold

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of the required information may also be an irretrievable expense. (4 marks).

Assessment of Network Infrastructure Company. This seems more


straightforwardly to be unlikely to be contestable. Laying competing
telephone lines is likely to be seen as prohibitively expensive by new
entrants. However, what about alternative technologies, such as satellite and
cable transmission? (4 marks)

10

Oligopoly (2 marks). There are a few large, interdependent firms suspected


Q12 of using market power (2 marks).

Definition of cost plus pricing – prices set by adding a constant mark-up to


(a) average costs. (2 marks) The data could then be explained in terms of
differences in average costs supplying CDs to different countries. E.g. 4
differences in transports costs or, if the CDs are made locally, differences in
(b) production costs (land, capital or labour costs). (4 marks) Also, allow an
explanation in terms of differences in standard mark-ups by directors
responsible for different countries.

Clear definition of sales maximization in terms of the maximum level of


output which can be produced without making a loss, ie, where AR=AC (2
marks) and profit maximization in terms of MR=MC (2 marks). 6
Appropriate diagram illustrating these two levels of output (3 marks).
(c) Explanation of resulting difference in prices, related to the data in the table
(3 marks).

Definition of cartel: formal, contracted, collusive agreements between


producers. (2 marks) Illustration – e.g. OPEC (2 marks).
10

(d)(i) Some analysis of the advantages of oligopolistic collusion. i.e. that the firms
involved can act as if a monopoly and thus gain supernormal profits 4
(supported with an appropriate diagram). Alternatively, some analysis of the
price-setting dilemmas of oligopolists, illustrated, for example, with a simple
(d)(ii) prisoners’ dilemma. Alternatively, the kinked demand curve will no doubt
make several appearances. (6 marks)

Effects on both consumers (5 marks) and producers (5 marks) should be


considered. The discussion of consumers should refer to consumer surplus
and choice. The discussion of producers to price, output, profit and 6
efficiency. Appropriate diagrams will add value. No detailed knowledge of
(e) the Competition Acts is required but candidates may draw on the passage.

For a level 5 mark answers must contain a significant level of evaluation.


This might include acknowledgement of the information problems of
implementing competition policy, the potential for lost economies of scale,
the potential damage to investment decision making if fines are imposed etc.
This may also impact on consumers in terms of reduced choice if too much
uncertainty is created.

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10

Exemplar Unit 4

Assessment Objectives Grid

Question Knowledge Application Analysis Evaluation TOTAL

SECTION A
Qu. 1 2 1 1 4
Qu. 2 1 1 1 1 4
Qu. 3 1 1 1 1 4
Qu. 4 2 1 1 4
Qu. 5 1 1 1 1 4
Qu. 6 1 1 1 1 4
Qu. 7 1 1 1 1 4
Qu. 8 2 1 1 4
Qu. 9 2 1 1 4
Qu. 10 2 1 1 4

Total 15 10 10 5 40

SECTION B

Qu. 11(a)(i) 2 1 1 4
Qu. 11(a)(ii) 1 1 2 4
Qu. 11(a)(iii) 2 2 2 2 8
Qu. 11(b) 2 4 4 10
Qu. 11(c) 2 1 1 4
Qu. 11(d) 2 4 4 10

Total 5 10 14 11 40

Qu. 12(a) 2 2 4
Qu. 12(b) 2 2 2 6
Qu. 12(c) 2 4 4 10
Qu. 12(d)(i) 1 2 1 4
Qu. 12(d)(ii) 2 3 1 6
Qu. 12(e) 4 6 10

Total 5 10 14 11 40

Section B as
% of marks 12.5 25 35 27.5

Section A & B
As % of marks 25 25 30 20

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