2016 JC1 H2 Economics / CA3 / Essay Test

Lecture Group 1 & 3

The construction of a third runway for Heathrow Airport could expose larger number of people
to aircraft noise. The emissions from aircraft and airport vehicles could also increase
concentrations of harmful gases, reducing the air quality around the airport.
http://www.aef.org.uk/2016/04/01/mayor-of-london-report-expanding-heathrow-would-
create-health-costs-up-to-25-billion/

Explain how expansion of Heathrow Airport can lead to market failure. [10]

Suggested Answer (a)

Focus Skills Context

 Expansion of Heathrow  Explain how  Construction of third
Airport runway for Heathrow
 Market failure – negative Airport
externality

INTRODUCTION
 Explain Market failure
 Identify the source of market failure: expansion of Heathrow Airport leads to market failure
(negative externalities).

Body Paragraphs
A. Free Market
In the construction of the third runway, Heathrow would only consider their
 Private cost: cost of constructing the third runway such as wages paid to the construction
firms and engineers and cost of raw material
 Private benefit: larger capacity  greater ability to receive more flights per day and serve
more tourists  higher revenue and hence profits
 Heathway aim to maximize their satisfaction and would only account for their private costs
and benefits, ignoring the external cost.
 Market equilibrium occurs at Qm amount of runway, where MPB=MPC.

Benefit/ Costs/ Price

MSC
B

E MPC
1 E

MPB= MSB

O Qs Qm Qty of runways

1
 B. Explain why free market falls to allocate resources efficiently
 Heathrow ignores the external cost of constructing the third runway on the third party
 Eternal cost:
o Air pollution → medical cost on the families staying near the third runway;
o Noise pollution → increase stress level
 Due to MEC, MSC > MPC
 When the external cost is taken into consideration, MSB=MSC  socially optimal amount of
output=Qs
 However, Qm > Qs  over production of runway (by the amount QsQm) & over allocation
of resources
 From Qs to Qm: MSC>MSB  deadweight loss is area E1EB

CONCLUSION:
 Free market leads to over allocation of resources
 Government intervention needed to prevent Heathrow from constructing the third runway

Level Description Marks

L3  Well-developed explanation of how market fails when externalities are present 8-10
and its impact on resource allocation
 Excellent application of concepts by integrating the examples into the
explanation.
 Diagrams are accurately drawn and well labelled with good explanation

L2  Developed explanation of how market fails when negative externalities are 5-7
present
 Some attempt at using diagram for analysis. Explanation of the diagram is not
well-developed.
 Some application of concepts by mentioning the examples in the explanation.

L1  Answer is mostly irrelevant 1-4

 Conceptual error.
 Undeveloped explanation of negative externality

2
Lecture Group 2
Many of our plastic bags either end up in the landfill or burned. And either solution is very poor
for the environment. An estimated 300 million plastic bags end up in the Atlantic Ocean alone,
posing threat to the sea life.

Explain why the use of plastic bags creates market failure.

[10]

Suggested Answer (a)

Focus Skills Context

 Use of plastic bags
 Market failure – negative
externality
 Explain why  Plastic bags
 Plastic bags endanger sea
life
 Burning of plastic bags
leads to air and land
pollution

INTRODUCTION
 Explain Market failure
 Identify the source of market failure: use of plastic bags leads to market failure (negative
externalities).

Body Paragraphs
C. Free Market
Consumers use plastic bags with the aim of maximizing satisfaction (intended outcome)
 Consumers would only consider their:
o Private cost: cost of plastic bags
o Private benefit: ease of carry of items/convenience
 Consumers aim to maximize their satisfaction and would only account for their private costs
and benefits, ignoring the external cost.
 Market equilibrium occurs at Qm amount of plastic bags, where MPB=MPC.

Benefit/ Costs/ Price

MSC
B

E MPC
1 E

MPB= MSB

O Qs Qm Qty of Plastic bags

3
 D. Explain why free market falls to allocate resources efficiently
 Consumers would ignore external cost on the third party
 Eternal cost:
o In order to dispose the plastic bags, the plastic bags are burned  air pollution →
medical cost incurred by the rest of the society
o Plastic bags are disposed in the landfill in an attempt to dispose them. This leads to
land pollution  release of harmful chemicals into the soil  reduce arable lands
for farmers
o Plastic bags endanger marine life → destroy the ecosystem & reduce the number of
fishes that fishermen can catch.
 Due to MEC, MSC > MPC
 When the external cost is taken into consideration, MSB=MSC  socially optimal amount of
output=Qs
 However, Qm > Qs  over usage of plastic bags (by the amount QsQm) & over allocation of
resources
 From Qs to Qm: MSC>MSB  deadweight loss is area E1EB

CONCLUSION:
 Free market leads to over allocation of resources
 Government intervention needed to reduce the usage of plastic bags to the socially optimal
level

Level Description Marks

L3  Well-developed explanation of how market fails when externalities are present 8-10
and its impact on resource allocation
 Excellent application of concepts by integrating the examples into the
explanation.
 Diagrams are accurately drawn and well labelled with good explanation

L2  Developed explanation of how market fails when negative externalities are 5-7
present
 Some attempt at using diagram for analysis. Explanation of the diagram is not
well-developed.
 Some application of concepts by mentioning the examples in the explanation.

L1  Answer is mostly irrelevant 1-4

 Conceptual error.
 Undeveloped explanation of negative externality

4
Make-Up Test

Explain why pollution and congestion caused by cars are likely to cause market failure. [10]

Suggested Answer (a)

Focus Skills Context

 Pollution & congestion  Explain why  Car
caused by cars  Traffic congestion
 Market failure – negative  Air pollution
externality

INTRODUCTION
 Explain Market failure
 Identify the source of market failure: road usage leads to pollution & congestion and hence
negative externalities. Excessive road usage leads to market failure.

Body Paragraphs
E. Free Market
Car users make decision with the aim of maximizing satisfaction (intended outcome)
 Car users would consider their
o Private cost: road tax, cost of maintaining the car, cost of petrol and ERP
o Private benefit: convenience and comfort of using the car
 Car users aim to maximize their satisfaction and would only account for their private costs
and benefits, ignoring the external cost.
 Market equilibrium occurs at Qm amount of road usage, where MPB=MPC.

Benefit/ Costs/ Price

MSC
B

E MPC
1 E

MPB= MSB

O Qs Qm Road usage

F. Explain why free market falls to allocate resources efficiently

 Drivers would ignore the external cost on third party.
 Eternal cost:
o Pollution  medical cost incurred by rest of the society & global warming  poor
crop harvest
o Congestion  loss of man hour by the employers

5
  Due to MEC, MSC > MPC
 When the external cost is taken into consideration, MSB=MSC  socially optimal amount of
output=Qs
 However, Qm > Qs  over allocation of resources in the area of road usage (by the amount
QsQm)
 From Qs to Qm: MSC>MSB  deadweight loss is area E1EB

CONCLUSION:
 Free market leads to over allocation of resources
 Government intervention needed to reduce road usage to the socially optimal level

Level Description Marks

L3  Well-developed explanation of how market fails when externalities are present 8-10
and its impact on resource allocation
 Excellent application of concepts by integrating the examples into the
explanation.
 Diagrams are accurately drawn and well labelled with good explanation

(L3: Students must address BOTH congestion and pollution)

L2  Developed explanation of how market fails when negative externalities are 5-7
present
 Some attempt at using diagram for analysis. Explanation of the diagram is not
well-developed.
 Some application of concepts by mentioning the examples in the explanation.

L1  Answer is mostly irrelevant 1-4

 Conceptual error.
 Undeveloped explanation of negative externality

6
 Question (b)
(EITHER OR Question)

Lecture Group 1 & 3

Despite defying gravity in the last recession, even Apple Incorporated is not escaping now. But
some analysts noted that competitors such as Samsung Electronics Co Ltd and HTC Corp had
recently launched well-received new products and the growing supply of lower priced
smartphone devices from vendors such as Huawei Technologies and ZTE will pressure prices
even if the economy improves.
Adapted from Reuters, 28 July 2012

Using elasticity concepts, discuss the possible strategies that Chief Executive Officer (CEO) of
Apple Inc can adopt to raise the firm’s revenue. [15]

Suggested Answer (b)

Focus Skills Context

Elasticity of Demand- PED, Discuss the use of demand Apple Inc. smartphones
YED, XED, Impact on Sales elasticity concepts in relation market
Revenue to total revenue earned

Introduction:
(i) State that Apple Inc. (firms)
(a) aims to maximize profits (greatest TR-TC difference) – hence the need to make
decisions regarding revenue and costs.
(b) can only max. revenue by making revenue decisions that positively affects
components (price and quantity Apple products sold).
(ii) Apple Inc. CEO has to make inferences from the market environment (preamble) and
apply knowledge of the concepts:
(a) to project the likely revenue effects on Apple Inc.
(b) to put in place the appropriate strategies to maximise profits (raise its TR, lower TC
or both).

Background/Inference: Threats faced by Apple Inc.:

(i) Higher degree of substitutability of iPhones due to increased smartphones variety
(ii) Eroding degree of necessity (“must have”/exclusivity factor)
(iii) Bleak economic climate may make existing/new iPhone take a (now /increasingly) larger
proportion of contracting consumer income
(iv) consumers may be more price sensitive and view iPhones as becoming relatively more
expensive (to other price competitive brands or the general fall in price trend for
smartphones);
 Thinning profit margins

Development (Body Paragraphs):

1. Explain the nature of its PED

7
  Define and explain the concept of PED: Degree of responsiveness of qty demanded
to changes in its own price, cet par.
 Nature of Apple Inc. products such as iPhones  High PED many close
substitutes availability such as smartphones produced by Samsung, HTC, Hua Wei
etc.  implies a potential fall in TR or profits if nothing is done
How does this knowledge help owners increase sales revenue?
 Lower price or RRP (recommended retail price) of iPhones (as DD is now more price
elastic  fall in price leading to more than proportionate increase in quantity
demanded, to raise TR) -Diagram to be drawn and used to illustrate increase in TR
due to price fall
Evaluation: How it may not really be of practical use.
Apple Inc. may not be able to increase its total revenue if the price competition
breaks into a price war. As many smartphone companies are providing comparable
interface, price cuts can be appealing to many customers. Hence this may induce
rival companies to retaliate with lower prices so as not to lose out. This may lead to
a price war which may render the owners bankrupt as price reduction without cost
reduction will reduce profit earned.
 A more viable competition strategy is to use non-price strategies to make demand
more Price inelastic – embark on a marketing drive to preserve the “cult” following
(habitual consumption); exclusivity, uniqueness and add-on features to newer
products range e.g. iPhone 6+ (necessity) If successful, they may even entice more
people to switch over to use iPhones, thus increasing demand.
Evaluation: How it may not really be of practical use.
Advertising and other non-price strategies may be costly and even if TR increases
due to increase in demand, profit may be reduced. In the context of Apple Inc., the
use of non-price strategies may be appropriate and effective as it has substantial
funds to engage in advertising and innovation to develop better products etc.
 Increase supply of iPhones by exploiting greater EOS (large scale production) or
source for cheaper inputs to lower cost per unit  pass cost-savings to consumers
in term of lower price
[Teaching point: students unlikely to raise this point with little knowledge on market
structure]
However while the use of PED has its shortcomings, it is definitely useful in helping Apple
Inc. to increase TR as knowledge of PED does to a large extent help them decide on their
pricing strategy. Knowledge of PED also enables Apple Inc. to anticipate the rise in qty
demanded so that they can ensure sufficient amount of food to prevent shortages and
inadequate supply to meet the increased demand.

2. Explain the nature of its XED

 Define and explain the concept of XED: Degree of responsiveness of demand for
Apple Inc. products as a result of change in price of related goods, cet par.
 Nature of goods related to Apple Inc. products

8
 Well-received smartphones by competitors (Samsung & HTC) implies degree of
substitutability of iPhones to consumers has gotten closer  Strong positive XED
with other smartphones produced by rival firms such as Samsung with comparable
quality. The existence of many smartphone models offering different features/
specialties such as different internal specifications such as automatic optimal image
stabilisation feature for clearer pictures and, interfaces etc. imply existence of
strong substitutes & consumers may swing away from using Apple’s products
means DD (or market share) may have fallen & is more cross elastic in DD.
 Similarly, smartphones have good complementary relationships with other firms.
They have high negative XED with these complementary companies such as apps
developer firms, automobile manufacturers, peripheral (smartphone accessories)
manufacturers etc. For example, Apple Inc. partnered with major automobile
manufacturer to roll out CarPlay feature. CarPlay feature pledges to make the use
of iphone in the car smarter, safer. It is a car’s built-in display that enables drivers
to just plug in their iPhone and get directions, make calls, send & receive messages,
listen to music etc. while staying focused on the road. Just plug in your iPhone and
go.
How does this knowledge help owners increase its sales revenue?
 Owners need to be aware of various price and non- price strategies taken by other
competitive smartphone companies, The objective is to reduce the value of the
positive XED. Knowing XED helps owners to be more aware of competitive price
strategies and match its rival’s pricing to increase its own sales revenue.
Evaluation: How it may not really help
Price competition is dangerous as price reduction without reduction in cost will
reduce profit and may force the firm to go bankrupt should price war occur among
competing restaurants.
 reduce the substitutability/re-establish uniqueness of iPhones
o Preserve/Enhance the “cult” (exclusivity or must-have) status of iPhones
through aggressive marketing and advertising  if able to effective entice non
iPhones users into Apple Inc.’s market, it will increase the client base and
increase their total revenue.
o Product promotions & developments to enhance uniqueness of iPhones  e.g.
iPhone 6+ offers better optical image stabilisation given improved motion
coprocessor, and lens of the camera itself to offer optical image stabilization.
Apple also added a barometer into the mix to enable apps to more accurately
track location etc.
Evaluation: How it may not really help
Success of joint projects also depends on how well-managed the partnership is to
enable long-term partnering. In addition, it also depends on how cost-efficient is the
partnership/ joint ventures in impacting the profit margins.
Some complementary services add more to cost than revenue, reducing profit.

9
 However XED is useful as it enables owners to identify its competitors and sectors that are
complementary to it. This is important in deciding on its marketing and non- price
strategies, including long term strategies to create more unique and innovative
smartphone interface.

3. Explain the nature of its YED.

 Define and explain the concept of YED: Degree of responsiveness of demand to
changes in income, cet par.
 Nature of smartphones positive YED and high  As income rises demand rises
by larger percentage.
 More of a luxury than a necessity. Most people would buy iPhones for its exclusive
and high quality features. However if income falls, they may see less need to
purchase iPhones and turn to cheaper alternatives such as Huawei or Xiaomi
smartphones.
 It’s YED is definitely higher than several smartphone models by Huawei & Xiaomi.
Hence an increase in income is expected to lead to DD increasing by a larger
percentage.
How does this knowledge help owners increase sales revenue?
Actual YED value enable owners to predict the percentage rise/ fall in sales as a
result of an expected rise/ fall in income and thus undertake strategies to
increase demand.
In times of negative economic growth, purchasing power of consumer may be
on the decline as such sales turnover due to consumers purchasing a
new/replacement phone (upgrading to a smartphone) is declining  falling
market DD/sales
(Vice versa for strong economic growth)

Need to promote greater market penetration to non-iPhone users & upgrading

by current Smartphone/iPhone users
 Product development /proliferation
o During periods of strong growth, Apple Inc. can offer premium features (e.g.
Siri for different languages e.g. Mandarin)
o More attractive newer generation iPhones (e.g. a more compact and better
functionality iPhone6 and iPhone 6+)
 Need to promote greater market penetration to non-iPhone users (widen
consumer base)
o Promote latest iPhone models to economies recording positive growth rates
(e.g. emerging economies)
o Promote iPhone models to untapped emerging countries depending on
their telecommunication infrastructural capability (earlier iPhone models
without the 3G network).

10
  Preserve/Enhance the “must-have” mentality (necessity) among consumers
aggressive marketing and advertising. Thus, even if in economy slowdown, the
fall in DD would be less significant.

Evaluation: How it may not really help

 Unless there are changes in National Income and purchasing power, YED may not
really be of use to the CEO of Apple Inc.
 Furthermore, most people may still choose to purchase iPhones due to its well-
designed interface and availability to mobile apps that raise convenience
significantly. Thus, demand may not fall as much as predicted.
 Venturing into emerging economies may not always be easy due to different in
consumers’ taste & preferences as well as under-developed telecommunication
facilities. Thus, in emerging countries where telecommunications services are less
developed, Apple Inc. may choose to put it expansion plans on hold.

Body (limitations of using elasticity concepts):

Elasticity concepts may not be relevant to the Apple Inc. CEO due to their
associated/conceptual limitations
 Availability & accuracy of elasticity data – may not be easily available to Apple Inc. CEO.
 Process of gathering information to measure elasticity takes time - manpower must be
deployed to gather information so as to determine the degree of elasticities.
 Elasticity of demand concepts does not reveal other types of information (assumes
ceteris paribus) that may be useful in decision-making. Other factors may include, taste
and preferences of consumers, technological advancement, population size etc.
Difficulty in gathering the elasticity values to devise strategies to increase total
revenue. Apple Inc.’s competitors may not readily disclose their information on pricing
and sales as these are usually confidential.

Conclusion:
A reasoned judgment alluding to the most relevant concept to the Apple Inc. CEO towards
achieving its intended objective of raising revenues.

Knowledge, Understanding, Application, Analysis

Level Descriptor Mark
3  A detailed explanation of how elasticity concepts could help the Apple 8-10
Inc. CEO to make decisions with limitations of the elasticity concepts for
decision-making.
 Relevant examples to support explanation
 Well-structured answer (showing good transition and is coherent in the
development of the argument).

(Note: A good answer should consist of 3 well-explained elasticity concepts

with limitations)
2  (Unbalanced) Detailed explanation of elasticity concepts could help 5-7

11
 the Apple Inc. CEO to make decisions without the limitations of the
elasticity concepts for decision-making.
OR
 Descriptive explanation of elasticity concepts on the various possible
strategies CEO of Apple Inc. could with brief consideration of
limitations of the elasticity concepts.
 Some examples provided but may not be appropriate/ relevant.
 Answer may not be well structured (argument is less coherent and has
little use of transitional statements)

1  A theoretical explanation of how elasticity concepts could help the 1-4

firm make decisions without the limitations of the concepts for
decision-making. More of listing of points - lacking in elaboration of
how elasticity concept can be useful to Apple Inc.
 Some conceptual errors/ inaccuracies.
 Little/ no relevant examples provided.
 Answer is not well structured

E3 Answer arrives at an analytically well-reasoned judgement and decisions 4-5

on the possible strategies firm (CEO of Apple Inc.) can adopt to raise
revenues. This can include
 the cost-benefit analysis in the use of possible strategies
 the relevance and effectiveness of strategies to the firm (Apple
Inc.) in achieving the aim of raising revenues
 analysis on the assumptions made – showing understanding that
there are broader scope of factors that can affect choice of
strategies

E2  For an answer that makes some attempt at evaluation or draw a 2-3

conclusion which addresses the choice of possible strategies the firm
(CEO of Apple Inc.) can adopt to raise revenues but does not explain the
judgement or base it on analysis.

E1  Answer provided an unsupported evaluative statement. 1

12
Lecture Group 2

McDonald’s Corp has waged a successful comeback effort under chief executive officer Steve
Easterbrook, posting its best quarterly growth after a move to serve breakfast all day helped
fuel US sales. Its revenue in the period was US$6.34 billion (S$9.07 billion), up from a
US$6.23 billion.
Adapted from TODAY, 26 Jan 2016
http://www.todayonline.com/business/mcdonalds-growth-surges-thanks-all-day-breakfast

Using elasticity concepts, discuss the possible strategies that restaurants such as McDonald
can adopt to raise the firm’s revenue. [15]

Suggested Answer (b)

Focus Skills Context

Elasticity of Demand- PED, Discuss the use of demand Restaurant business such as
YED, XED, Impact on Sales elasticity concepts in relation McDonald
Revenue to total revenue earned

Introduction:
(i) State that restaurants such as McDonald
(c) aims to maximize profits (greatest TR-TC difference) – hence the need to
make decisions regarding revenue and costs.
(d) can only max. revenue by making revenue decisions that positively affects
components (price and quantity McDonald products sold).
(ii) Restaurants such as McDonald has to make inferences from the market environment
(preamble) and apply knowledge of the concepts:
(e) to project the likely revenue effects on McDonald.
(f) to put in place the appropriate strategies to maximise profits (raise its TR,
lower TC or both).

Background/Inference: Threats faced by McDonald:

(i) Higher degree of substitutability due to increase competition from existing
restaurants and new restaurants entering market such as 4 Fingers, Dunkin Donuts,
Burger King etc. There are many restaurants; selling exclusive, special cuisine that
can be found readily in many shopping centres or heartland areas
(ii) Nature of restaurant meals – may be considered more of a luxury than a necessity.
(iii) Bleak economic climate may lead to consumers seeking for thrifty/ more value-for-
money meal options
(iv) consumers may be more price sensitive and McDonald meal as expensive (relative
to other price competitive restaurants/brands);
 Thinning profit margins

Development (Body Paragraphs):

1. Explain the nature of its PED
 Define and explain the concept of PED: Degree of responsiveness of qty
demanded to changes in its own price, cet par.

13
  Nature of restaurant meals such as McDonald  High PED more of luxury
than a necessity
Availability of many substitutes especially for the average income earners who
can turn to hawker food or other food outlets.
How does this knowledge help owners increase sales revenue?
 Knowledge of PED enables owners to make effective pricing decisions. Knowing
that its PED is relatively high, owners can provide discounts for its meals so that
qty demanded will increase more proportionately, increasing its total revenue.
(diagram to be drawn and used to illustrate increase in TR due to price fall)
 Provide special discount rates to certain income groups with higher PED such
as students or during non- peak periods like weekdays and weekday afternoons.
E.g. student meals, Happy Meal
Evaluation: How it may not really be of practical use.
Restaurant owners such as McDonald may not be able to increase its total
revenue if the price competition breaks into a price war. As many restaurants
sell meals that are similar, price cuts can be appealing to many customers.
Hence this may induce rival restaurant owners to retaliate with lower prices so
as not to lose out. This may lead to a price war which may render the owners
bankrupt as price reduction without cost reduction will reduce profit earned.
Hence, if McDonald starts cutting its price on its meals, Burger King, KFC etc.
may also do so and this is detrimental to the restaurant owners’ profit margin.
 A more viable competition strategy is to use non-price strategies through
advertising, branding and improvising on the menus to reduce PED. Such
marketing strategies are aimed at making their meals or services more unique,
thus reducing the PED value. If successful, they may even entice more people to
visit the restaurants, thus increasing demand.
In the case of McDonald, it introduced All Day Breakfast option for example
which lead to the boost in its sales revenue as more consumers started
patronizing McDonald. Similarly, McDonald raises its brand awareness through
promotion via TV, billboard, flyers and internet to make it more appealing than
other restaurants.
Evaluation: How it may not really be of practical use.
Advertising and other non-price strategies may be costly and even if TR
increases due to increase in demand, profit may be reduced. In the context of
McDonald, the use of non-price strategies may be appropriate and effective as
it has substantial funds to engage in advertising etc.

However while the use of PED has its shortcomings, it is definitely useful in helping
the restaurant owners increase TR as knowledge of PED does to a large extent help
them decide on their pricing strategy. Knowledge of PED also enables restaurant
owners to anticipate the rise in qty demanded so that they can ensure sufficient
amount of food to prevent shortages and inadequate supply to meet the increased
demand.

2. Explain the nature of its XED

 Define and explain the concept of XED: Degree of responsiveness of demand for
restaurant meals as a result of change in price of related goods, cet par.

14
  Nature of goods related to restaurant meals
Strong positive XED with other restaurants of comparable quality. The existence
of many restaurants offering different specialties, different type of services and
ambiance imply existence of strong substitutes.
 Similarly, restaurants have good complementary relationships with other. They
have high negative XED with these companies.

How does this knowledge help owners increase its sales revenue?
 Owners need to be aware of various price and non- price strategies taken by
other competitive restaurants. Many restaurants in bad economic times for
example will try to maintain their sales by undercutting their rivals or create
new menus that are cheaper and yet attractive. The objective is to reduce the
value of the positive XED. Knowing XED helps owners to be more aware of
competitive price strategies and match its rival’s pricing to increase its own
sales revenue.
Evaluation: How it may not really help
Price competition is dangerous as price reduction without reduction in cost will
reduce profit and may force the firm to go bankrupt should price war occur
among competing restaurants.
 Undertake non price strategies such as providing more personal services,
wireless network, better and more comfortable sofas to enhance dining
experience etc. Other non-price strategies that McDonald has ventured into to
reduce its substitutability includes providing healthier options to attract
consumers who are increasing more health conscious as well as broadening the
menu options to include coffee-house-style food and drinks through McCafé.
 Owners can also take advantage of the strong complementary relationship
restaurants have with other industries such as tie-up with Disney, providing
Happy meals with Disney character toys such as Minions etc. These will enable
them to tap on a larger client base to increase their total revenue.
Evaluation: How it may not really help
 Success of joint projects also depends on how well-managed the
partnership is to enable long-term partnering. In addition, it also depends
on how cost-efficient is the partnership/ joint ventures in impacting the
profit margins.
 More complementary services in restaurant meals e.g. wireless network,
comfortable sofas to attract customers may add more to cost than revenue,
reducing profit.

However XED is useful as it enables owners to identify its competitors and sectors that
are complementary to it. This is important in deciding on its marketing and non- price
strategies, including long term strategies to create more unique and exclusive meals.

3. Explain the nature of its YED.

 Define and explain the concept of YED: Degree of responsiveness of demand to
changes in income, cet par.
 Nature of restaurant meals positive YED and high  As income rises
demand rises by larger percentage.

15
  More of a luxury than a necessity. Most people would eat in restaurants such as
McDonald for its exclusive cuisine and quality service provided. However if
income falls, they may see less need to eat in such restaurants and turn to
cheaper alternatives such as hawker food.
 It’s YED is definitely higher than food in hawker centres. Hence an increase in
income is expected to lead to demand increasing by a larger percentage.
How does this knowledge help owners increase sales revenue?
 Actual YED value enable owners to predict the percentage rise/ fall in sales as a
result of an expected rise/ fall in income and thus undertake strategies to
increase demand.
 As standard of living increase and in times of good economic growth, restaurant
owners can expect more people to visit restaurants such as McDonalds. They
can take advantage of this knowledge by ensuring enough meals and varieties
provided and that the capacity and seats available are sufficient to cater to the
larger number of customers.
 However, in times of economic slowdown, McDonald restaurant owners can
provide more value-for-money meal options to appeal to the average income
earners.
 Postpone any plans to open new outlets or to expand its existing outlets.
Evaluation: How it may not really help
 Unless there are changes in National Income and purchasing power, YED may
not really be of use to the owners.
 Furthermore, most people may still choose to dine in places such as McDonald
which are relatively less expensive than fine-dining restaurants. Thus, demand
may not fall as much as predicted.
 Venturing into emerging economies may not always be easy due to different in
consumers taste & preferences. Thus, McDonald has to also take into account
the culture of the countries when planning for expansion.
However, knowing the value of YED for its meals would help the owners in its future
expansion plans such as venturing into emerging economies. As when economy
progresses and standard of living improves, such restaurant meals may become more of
a necessity. This helps restaurants such as McDonald decide on how much to expand its
restaurant and the type of food and service to provide.

Body (limitations of using elasticity concepts):

Elasticity concepts may not be relevant to restaurants such as McDonald due to their
associated/conceptual limitations
 Elasticity data are based on past data, and tastes and preferences of consumers
can change over time.
 There are many other factors other than price, income and prices of related goods
that will affect the demand of restaurant meals. In other words, the ceteris paribus
assumption may not actually hold true. Other factors may include, taste and
preferences of consumers, technological advancement, population size etc.
 Process of gathering information to measure elasticity takes time - manpower
must be deployed to gather information so as to determine the degree of
elasticities.

16
  Difficulty in gathering the elasticity values to devise strategies to increase total
revenue. Competitors may not readily disclose their information on pricing and sales
as these are usually confidential.

Conclusion:
All three are to some extent of practical use, the most useful being PED as it has direct
impact on the owners’ pricing and thus revenue earned. Even then, these concepts need to
be used with caution due to the limitations mentioned above.

(A reasoned judgment alluding to the most relevant concept to restaurants such as

McDonald towards achieving its intended objective of raising revenues.)

Knowledge, Understanding, Application, Analysis

Level Descriptor Mark
3  A detailed explanation of how elasticity concepts could help restaurants 8-10
such as McDonald to make decisions with limitations of the elasticity
concepts for decision-making.
 Relevant examples to support explanation (contextualization)
 Well-structured answer (showing good transition and is coherent in the
development of the argument).

(Note: A good answer should consist of 3 well-explained elasticity concepts

with limitations)
2  (Unbalanced) ) Detailed explanation of elasticity concepts could help 5-7
restaurants such as McDonald to make decisions without the limitations
of the elasticity concepts for decision-making.
OR
 Descriptive explanation of elasticity concepts on the various possible
strategies restaurants such as McDonald could adopt with brief
consideration of limitations of the elasticity concepts.
 Some examples provided but may not be appropriate/ relevant.
(contextualization)
 Answer may not be well structured (argument is less coherent and has
little use of transitional statements)
1  A theoretical explanation of how elasticity concepts could help the firms 1-4
make decisions without the limitations of the concepts for decision-
making. More of listing of points - lacking in elaboration of how the
elasticity concept can be useful to the restaurants such as McDonald.
 Some conceptual errors/ inaccuracies.
 Little/ no relevant examples provided.
 Answer is not well structured

E3 Answer arrives at an analytically well-reasoned judgement and decisions 4-5

on the possible strategies restaurant such as McDonald can adopt to raise
revenues. This can include
 the cost-benefit analysis in the choice of possible strategies
 the usefulness and effectiveness of strategies to the restaurants

17
 such as McDonald in achieving the aim of raising revenues
 analysis on the assumptions made – showing understanding that
there are broader scope of factors that can affect choice of
strategies

E2  For an answer that makes some attempt at evaluation or draw a 2-3

conclusion which addresses the choice of possible strategies restaurant
such as McDonald can adopt to raise revenues but does not explain the
judgement or base it on analysis.

E1  Answer provided an unsupported evaluative statement. 1

18
Make-Up Test

The price of a PlayStation 3 Video Game console was US$599 when it was first released in
2006. Today, one can easily own a PlayStation 3 console for US$450.

Using elasticity concepts, consider the strategies that can be adopted for Sony, the maker of
PlayStation 3, to increase its revenue. [15]

Suggested Answer (b)

Focus Skills Context

Elasticity of Demand- PED, Discuss the use of demand Sony’s business, the maker of
YED, XED, Impact on Sales elasticity concepts in relation PlayStation 3
Revenue to total revenue earned

Introduction:
(i) State that Video game console firm such as Sony – the maker of PlayStation (PS) 3
(a) aims to maximize profits (greatest TR-TC difference) – hence the need to
make decisions regarding revenue and costs.
(b) can only max. revenue by making revenue decisions that positively affects
components (price and quantity PlayStation (PS) 3 products sold).
(ii) Video game console firm such as Sony – the maker of PlayStation (PS) 3 has to make
inferences from the market environment (preamble) and apply knowledge of the
concepts:
(a) to project the likely revenue effects on Sony.
(b) to put in place the appropriate strategies to maximise profits (raise its TR,
lower TC or both).

Background/Inference: Threats faced by Video game console firm such as Sony:

(i) Higher degree of substitutability due to increase competition from existing video
game console firms such as XBox etc. which offer relatively comparable gaming
experience.
(ii) consumers may be more price sensitive given presence of close substitutes
 Thinning profit margins

Development (Body Paragraphs):

1. Explain the nature of its PED
 Define and explain the concept of PED: Degree of responsiveness of qty
demanded to changes in its own price, cet par.
 Nature of PS 3  High PED due to availability of other substitutes from Xbox
or Nintendo Wii
Newly launched Playstation 3 will have price inelastic demand. So can set high
price to raise TR. But over time, demand may become price elastic with
introduction of similar products by rival firms (substitutes available). So Sony
may have to lower price to raise TR.
(PlayStation 4 has also been released into market in 2013  PS 3 is increasingly
seen as an inferior products)

19
 How does this knowledge help owners increase sales revenue?
 Knowledge of PED enables owners to make effective pricing decisions. Knowing
that its PED is relatively high, owners can provide special discount rates for PS 3
so that qty demanded will increase more proportionately, increasing its total
revenue. (Diagram to be drawn and used to illustrate increase in TR due to price
fall)
 Non-pricing Strategy (using PED) - By making its demand less elastic (less of a
substitute)
o Both improving image and advertising, if very successful, not only increase
demand, but also pr elasticity of demand less elastic as people tend to think
PlayStation game console is the BEST game console in contrast to other
consoles. Even for new Sony video console, PS 4, it is still the preferred
option over Xbox One and Wii U.
With higher demand and more price inelastic demand, Sony can maintain
high price to gain higher revenue. (Illustrate this with diagram)
(Students are expected to explain elastic demand and why demand become
less price elastic)
Evaluation: How it may not really be of practical use.
Sony, maker of PlayStation console may not be able to increase its total
revenue if the price competition breaks into a price war. As game console
are largely similar, price cuts can be appealing to many customers. Hence,
the use of price strategy may not be a sustainable option for Sony, instead a
more viable option would be to engage in non-price strategy.
o Improvement in gaming feature of PS 3 to enhance gaming experience,
aggressive advertising or product innovation by developing new product,
PS 4: fitted with a new Blu-Ray Technology which provides realistic graphics
and non-existent lag time in playing. Additionally new programmes and
features such as online gaming with other PS3 users, sharing/chatting
platforms on the PS3 helps to distinguish itself from other game consoles.
(Make use of the concept of PED and XED to analyse the competitors’ game
console features and how Sony might be able to distinct itself from the rest)
Evaluation: How it may not really be of practical use.
Advertising and other non-price strategies may be costly and even if TR
increases due to increase in demand, profit may be reduced. In the context
of Sony, the use of non-price strategies may be appropriate and effective as
it has substantial funds to engage in advertising etc.
However while the use of PED has its shortcomings, it is definitely useful in helping
Sony increase TR as knowledge of PED does to a large extent help them decide on
their pricing strategy. Knowledge of PED also enables Sony to anticipate the rise in
qty demanded so that they can ensure sufficient amount of food to prevent
shortages and inadequate supply to meet the increased demand.

2. Explain the nature of its XED

 Define and explain the concept of XED: Degree of responsiveness of demand for
Sony PS 3 as a result of change in price of related goods, cet par.
 Nature of goods related to Sony PlayStation 3

20
 Strong positive XED- many video game consoles of comparable quality available
in market imply existence of strong substitutes.
Use diagram to explain how increasing demand for the good can increase
Sony’s revenue from the sale of its Playstation game console.
 Similarly, video game console firm, Sony may have good complementary
relationships with other firms such as video game developers/ creators, action
camera maker firms etc. They have high negative XED with these companies.
For instance, Sony has recently partnered with video game creator, Kojima
Productions for a new exclusive PlayStation game. Similarly, Sony PlayStation
has partnered with GoPro to stream video. This would enable gamers around
the world to access to GoPro content as well as browse GoPro cameras and
accessories.
How does this knowledge help owners increase its sales revenue?
Owners need to be aware of various price and non- price strategies taken by other
video game console firms.
 Increase Demand for Sony’s playstation by: provide complements
• complements as free gift e.g. free games software, free stick
• Offer complements at a discount
• Sale with complements as package – e.g. Console+stick+software
• Collaboration with game manufacturers to secure special release only on
PS3. E.g. With the rise of mobile gaming, there's a huge new audience of
gamers who are gobbling up smaller, indie-developed games. Sony is
winning over game developers with PS4, embracing indies to the point of
featuring them on stage at its E3 press conference alongside its big budget
exclusives.
Evaluation: How it may not really help
 Success of joint projects also depends on how well-managed the
partnership is to enable long-term partnering. In addition, it also depends
on how cost-efficient is the partnership/ joint ventures in impacting the
profit margins.
 More complementary services provided may add more to cost than revenue,
reducing profit.

• Increase Demand for Sony’s playstation by: reducing substitutability

• Improve gaming experience – qualitative improvement through product
innovation
• Marketing & advertising
Evaluation: How it may not really help
• Advertising and other non-price strategies may be costly and even if TR
increases due to increase in demand, profit may be reduced. In the context
of Sony, an established firm, it has the budgetary capacity to engage in both
production innovation and advertising to reduce its products’
substitutability.

However XED is useful as it enables owners to identify its competitors and sectors
that are complementary to it. This is important in deciding on its marketing and non-
price strategies, including long term strategies to create more unique and exclusive
meals.

21
 3. Explain the nature of its YED.
 Define and explain the concept of YED: Degree of responsiveness of demand to
changes in income, cet par.
 Nature of Video game console  positive YED and high  As income rises
demand rises by larger percentage.
 More of a luxury than a necessity. Most people would only purchase the video
game console when income rises. However if income falls, they may see less
need for it and turn to cheaper alternatives such massively multiplayer online
role-playing game (MMORPG).
 Its YED is definitely higher than many online games such as MMORPG. Hence an
increase in income is expected to lead to demand increasing by a larger
percentage.
How does this knowledge help owners increase sales revenue?
 Actual YED value enable owners to predict the percentage rise/ fall in sales as a
result of an expected rise/ fall in income and thus undertake strategies to
increase demand.
 Sony to time launching of new models or games when income is rising  rise in
DD for new models  raise in TR for Sony
 Over time the older models of Playstation may become inferior good with
negative YED. Hence, Sony can consider selling older models to emerging
countries where video game market is less developed. Thus, PlayStation 3 may
be seen as a luxury product.
Evaluation: How it may not really help
Unless there are changes in National Income and purchasing power, YED may
not really be of use to the owners.

Body (limitations of using elasticity concepts):

Elasticity concepts may not be relevant to video game console firm such as Sony due to
their associated/conceptual limitations
 Elasticity data are based on past data, and tastes and preferences of consumers
can change over time.
 There are many other factors other than price, income and prices of related goods
that will affect the demand of video game console firm. In other words, the ceteris
paribus assumption may not actually hold true. Other factors may include, taste and
preferences of consumers, technological advancement, population size etc.
 Process of gathering information to measure elasticity takes time - manpower
must be deployed to gather information so as to determine the degree of
elasticities.
 Difficulty in gathering the elasticity values to devise strategies to increase total
revenue. Competitors may not readily disclose their information on pricing and sales
as these are usually confidential.

Conclusion:
 All the above strategies are useful provided that Sony’s competitors remain docile
with no retaliating strategies of their own.

22
  Sony needs to constantly fine-tune its product or launch newer and different
versions to allow the PED to remain low, or XED to be positively inelastic compared
to other brands.
 In reality, Sony has managed to out-perform Xbox - Sony Sold 30.2 Million
PlayStation 4 Consoles, Nearly Double Microsoft's System.

Knowledge, Understanding, Application, Analysis

Level Descriptor Mark
L3  A detailed explanation of how elasticity concepts could help Sony, video 8-10
game console firm to make decisions with limitations of the elasticity
concepts for decision-making.
 Relevant examples to support explanation (contextualization – Sony,
video game console firm )
 Well-structured answer (showing good transition and is coherent in the
development of the argument).

(Note: A good answer should consist of 3 well-explained elasticity concepts

with limitations)
L2  (Unbalanced) Detailed explanation of elasticity concepts could help Sony, 5-7
video game console firm to make decisions without the limitations of the
elasticity concepts for decision-making.
OR
 Descriptive explanation of elasticity concepts on the various possible
strategies Sony could adopt with brief consideration of limitations of the
elasticity concepts.
 Some examples provided but may not be appropriate/ relevant.
(contextualization)
 Answer may not be well structured (argument is less coherent and has
little use of transitional statements)

L1  A theoretical explanation of how elasticity concepts could help the firm 1-4
make decisions without the limitations of the concepts for decision-
making. More of listing of points - lacking in elaboration of how the
elasticity concept can be useful to the Sony, video game console firm.
 Some conceptual errors/ inaccuracies.
 Little/ no relevant examples provided.
 Answer is not well structured

Allow up to 4 marks for evaluation

Answer arrives at an analytically well-reasoned judgement and decisions on 4-5
E3
the possible strategies restaurant such as Sony, video game console firm can
adopt to raise revenues. This can include
 the cost-benefit analysis in the choice of possible strategies
 the usefulness and effectiveness of strategies to Sony, video game
console firm in achieving the aim of raising revenues

analysis on the assumptions made – showing understanding that there are

23
 broader scope of factors that can affect choice of strategies
2-3
E2 For an answer that makes some attempt at evaluation or draw a conclusion
which addresses the choice of possible strategies Sony, video game console
firm can adopt to raise revenues but does not explain the judgement or base
it on analysis.
1
E1 Answer provided an unsupported evaluative statement.

24
Lecture Group 1, 2, 3 & Make-Up Test

Indonesia provides subsidized energy to its citizens as a public service obligation. The
rationale is that citizens should benefit from domestic production of oil, coal, and other
energy sources through cheap prices.
Adopted from Asian Development Bank (ADB), 2015

Discuss the effectiveness of a subsidy and price ceiling to prevent a rapid increase in prices.
[15]

Suggested Answer (b)

Focus Skills Context

Explain the use of subsidy Discuss the use of demand Context: Energy market
and price ceiling to reduce elasticity concepts in relation
energy prices. Evaluate the to total revenue earned
effectiveness of these
policies.

Introduction:

Objective of intervention
- Identify the objectives for subsidy and price ceiling – to ensure greater equity
- Prevent political crisis as a result of a reduction in social cohesion
- Explain what subsidy and price ceiling are - basically, they are forms of government
intervention to prevent the price of a good from being too high

Body:
Impact of a subsidy: Supply increases due to fall in COP  SS shift right  firm pass cost-
savings to consumers in term of lower price  Pe falls, Qe rises (illustrate with diagram)
- Extent of price fall: depends on the relative price elasticities of demand and supply.
- The more price inelastic the demand relative to supply, the greater the fall in price when
a subsidy is given to the production of energy  thus the more effective the subsidy is in
preventing a rapid increase in price as consumers would benefit from larger fall in price
of energy, in this case energy prices in Indonesia.
- Strengths and limitations:
o small time lags
o do not cause disequilibrium in the energy markets
o increase tax burden on tax payers
- Evaluation: This measure will be very effective if implemented on necessities and
especially if there is a significant proportion of the population living below the poverty
line who will benefit from the fall in prices of energy. In this case, as energy is a
necessity that is widely used by citizens in Indonesia, the use of subsidy would be
effective to achieve greater equity.
- Having said that, it is not a sustainable measure to rely on for a prolonged period of
time. For a significant proportion of population to benefit from this measure, the
amount of subsidy given has to be hefty which can lead a significant rise in the
government total expenditure. This may in turn increase the tax burden of taxpayers
and create a disincentive for work and investment. Thus, unless the Indonesia

25
 government is able to identify new source of revenues to finance the use of energy
subsidy, it would be more effective to use it as a short-term measure.

Impact of a price ceiling:

- Price of the energy such as oil is capped and not allowed to increase beyond the price
ceiling that is set by the government
- Shortage occurs as quantity demanded > quantity supplied at the price ceiling (illustrate
with diagram)
- Government has to consider how to distribute the amount of energy sources such as oil
available through “first come, first served” basis or a rationing system.
- Evaluation: While it is relatively easy for the government to prevent a rapid increase in
oil prices through an introduction of a price ceiling, the same cannot be said when it
comes to the decision about the beneficiaries of this measure. Ideally, the distribution of
this limited amount of goods should be made in such a way that the least privileged in a
society are the first to be the recipients of this measure, but this may not be the case in
reality if the rationing/distribution process is well-monitored.
- Black market might result if the producers have means to sell the fuel and other energy
sources illegally at a higher price (illustrate with diagram) If so, this will totally defeat the
purpose of implementing a price ceiling, which is to prevent a price increase. This is
likely to happen in countries where the governments could either be corrupt or
incapable of ensuring a tight enforcement of its legislation. Thus, the least privileged
may still not be able to benefit from the lower energy prices.

Overall Evaluation: considering the overall effectiveness of subsidy and price ceiling
- Subsidies work through market forces and can appear seemingly more palatable to the
providers of these goods (oil, coal, and other energy sources) that are experiencing rapid
increase in price as compared to a price ceiling.
- However, a subsidy may not be as quick as a price ceiling in preventing rapid price
increases especially in a situation where the increase in price is exponential and rapid.
- In addition, the effectiveness of price ceiling & subsidy are also dependent on level of
government efficiency and degree of corruptibility in Indonesia.
- Ultimately, both measures are likely to prove costly for any government if the increase
in prices is going to be persistent and can at best only be administered as short term
pain relievers for its citizens.
- More concrete long term measures targeted at reducing the size shortage (root cause)
which is the source of the rapid increase in prices is thus absolutely necessary.

Conclusion
- The choice of whether to use a subsidy or price ceiling to prevent a rapid increase in
prices depends on the objective of the Indonesia government, rate of increase in price of
these energy sources and circumstances facing the government.
- There is not likely to be a one-size fits all solution for the government. Different
governments facing different challenges will need to adopt the measure that is most
appropriate for them. Governments of various provinces in the entire country may also
need to tweak the implementation of these national measures in order to ensure the
best outcomes for its citizens.
- Having said that, both measures are not likely to be sustainable if the increase in prices
(which is based on market forces and are not within the control of any government in
the world) is going be persistent. It may be more worthwhile for Indonesia government
to think of ways to enable its citizens to improve their earning capacity so as to have
the purchasing power to cope with the rapid increase in prices.

26
 Knowledge, Understanding, Application, Analysis
Level Descriptor Mark
L3  Balanced and well-developed answer with sound explanation of the 2 policies 8-10
 Good use of diagrams to illustrate the impact of subsidy and price ceiling
 Relevant examples to support explanation (contextualize to Indonesia)
 Well-structured answer (showing good transition and is coherent in the
development of the argument).

L2  Explanation of the impact of subsidy and price ceiling, is incomplete or not 5-7
well developed
 Diagrams (if drawn) are incomplete or not explained
 Some relevant examples to support explanation and some attempt to
contextualize to Indonesia
 Answer has some structure to show transition and coherence in the
development of the argument.

L1  Theoretical description of subsidy and price ceiling without explaining the 1-4
impact
 Inaccurate explanation of subsidy and price ceiling
 Answer is largely irrelevant or contains conceptual errors

E3  Competent evaluation supported by economic analysis. Able to provide 4-5

factors that influence the decision of the use of price control and subsidy.
Factors such as level of govt. efficiency and corruption, the need for long term
measures to go along with price ceiling and subsidy.

E2  Evaluation is unexplained. For instance, answer simply mentioned the need to 2-3
consider broader range of measures or use long-term solutions to
compliment price control and subsidy without explaining the rationale.

E1  Answer provided an unsupported evaluative statement. 1

27