2010 TJC JC1 Economics Pre-Promotional Exam Revision Essays Part 1

EQ1 on Demand, Supply and Elasticity

Singapore Airlines (SIA) will launch the world's longest business class-only flights in mid-May. For its
non-stop flights to the United States, its current 181-seat two-class configuration will be converted into
100 business-class only seats. All economy-class travellers on SIA flights to the US will have to make
stopovers in Frankfurt, Tokyo or Taipei, which can increase travel time by as much as six hours.
Adapted from the Straits Times, 5th Mar 2008
(a) Using relevant examples, explain the concepts of price and cross elasticity of demand for business
and economy class tickets for flights between Singapore and the USA. [10]
L1: Knowledge (1- 2)

Define PED and CED

L2: Comprehension (3-5)

Explain the meaning of the magnitude and the sign of PED and CED

L3: Application and Analysis (6 -10)

Demand for air travel is derived from the demand for leisure and business travel
Business class seats are targeted at business travellers while economy class seats are targeted
at leisure travelers
Demand for business travel has lower PED than leisure travel
o
Business travel has higher degree of necessity than leisure travel
o
Airfare of the business traveller is paid by his company while the airfare of the leisure
traveller is paid by the individual
Business and economy class seats may not be close substitutes positive but low CED
o
Business class service and comfort levels are substantially better bigger and more
comfortable seats, more legroom, seats can recline much further, better food, better
in-flight entertainment
o
Superior comfort is much more important for long haul flights e.g. Singapore to USA
than for short haul flights e.g. Singapore to Bangkok

(b) Discuss the extent to which SIA is able to use the above elasticity concepts in deciding how to tweak
its airfares in order to maximize its earnings. [15]
L1: Knowledge (1-3)

Recognize that earnings can be measured by total revenue

Define total revenue as the product of price and output

L2: Comprehension (4-6)

Explain how to TR, a firm should P when PED >1 and P when PED <1
Explain why a multi product firm has to consider the CED between its own products when
deciding on any price change

2010 TJC JC1 Economics Pre-Promotional Exam Revision Essays Part 1

L3: Application, Analysis & Synthesis (7-11)

PED for business class seats likely to be inelastic ticket prices to TR

PED for economy class seats likely to be elastic ticket prices to TR
Business class prices some switch to economy class CED determines the extent of the
in demand, output & TR for economy class tickets
Economy class prices attract some travellers away from business class CED determines
the extent of the demand, output & TR of business class tickets
Knowing both PED and CED enables SIA to predict the overall impact on TR of concurrent
changes in the prices of both business and economy class seats

E: Evaluation (12-15)

The above analysis assumes that other airlines do not react to changes in SIAs ticket prices
which is unlikely given that the market for any flight route is likely to be oligopolistic
The estimates of PED and YED would have been obtained from past data, which may now be
irrelevant given that SIA will be drastically changing much of its flight scheduling

EQ2 on Government Intervention

(a) Explain price and income elasticity of demand.

[10]

L1: Define price and income elasticity of demand (1-3)

Price elasticity of demand (PED) measures the responsiveness of quantity demanded to change
in its price and is calculated by taking the percentage change in the quantity demanded for a
given percentage change in price
Income elasticity of demand (YED) measures the responsiveness of demand to change in
income and is calculated by taking the percentage change in demand for a given percentage
change in income

L2: Explain the meaning of the coefficient of PED and YED (4-6)

Demand curve is generally downward sloping inverse relationship between price and output
PED is always negative.
Positive YED in income causes in demand normal goods
Negative YED in income causes in demand inferior goods

L3: Explain the meaning of the magnitude (7-10)

PED > 1 => %Q >%P => P results in TR

PED < 1 => %Q < %P => P results in TR
0 <YED <1 => %Q < %Y => normal necessity
YED >1 => %Q > %Y => normal luxury

2010 TJC JC1 Economics Pre-Promotional Exam Revision Essays Part 1

(b) Discuss how the understanding of these concepts would help a government to decide on whether to
impose an output tax or a quota on the sales of cars.
[15]
L1: Define output tax, quota and state the aims of such policies (1-3)

Output tax a monetary charge placed on each unit of a good sold

Quota a quantitative restriction on the total amount of the good sold
Possible aims of these policies curb production/consumption, raise government revenue

L2: Explain and illustrate how output taxes and quotas work (4-8)

Output tax
o Shift supply curve upwards by the tax rate
o Rise in the equilibrium price and fall in the equilibrium output
o Tax revenue = (tax per unit) x (post tax equilibrium output)
Quota
o Maximum output is fixed below the free market equilibrium output
o Supply curve becomes vertical at the quota level the market price rises to where this
vertical supply cuts the market demand curve
o Government can allocate the quota amongst existing sellers either through administrative
measures or through auctions

L3: Analyze the price and income elasticities of the demand for cars (9-11)

Other forms of public transport like buses and trains are much less comfortable and often less
convenient the cars poor substitutes PED for cars likely to be inelastic
Many people tend to also see cars as status symbols normal luxuries positive YED and
income elastic

E: Discuss how price and income elasticity of demand affects the choice of policy (12-15)

Assume that the objective is to curb car ownership so as to reduce traffic congestion
Inelastic PED a very high rate of output tax is required to significantly car sales politically
unpopular quota may be preferable
Positive and elastic YED income rises with economic growth demand for cars more than
proportionately tax rates need to be revised upwards frequently or by large amounts in order
to curb car population politically unpopular quota may be preferable
If the government wishes to raise revenue as well quotas can be auctioned off
Hence given the low PED and high YED of new cars, a quota that is allocated via auctions
arguably better than an equivalent output tax

EQ3 on Economies of Scale and Size of Firms

Using appropriate examples, discuss whether all Singapore based companies aim to grow larger
because of the presence of economies of scale. [25]
L1: Define EOS and identify the various types of EOS (1-5)

Internal economies of scale (EOS) occur when the expansion of a firm results in falling average
(or unit) costs
Firms can experience plant (technical) or firm (non-technical) economies

2010 TJC JC1 Economics Pre-Promotional Exam Revision Essays Part 1

Types of plant economies multi stage production, increased dimensions, specialization of

labour, factor indivisibility, by-product economies
Types of firm economies organizational, marketing, financial economies, spreading of
overheads

L2: Explain and illustrate how different types of EOS can lead to lower unit costs (6-13)

Describe at least two plant and two firm EOS

Explain how such types of EOS leads to rising productivity and/or cost savings
Illustrate with examples of renowned Singapore based firms e.g. Singtel, SIA, Creative
Technologies, OSIM, DBS

L3: Analyze the reasons determining the size of firms (14-21)

Explain the concept of diseconomies of scale (disEOS) cost or productivity due to

complexity of operations and labour motivation
MES differ varies with different markets
o MES occurs at low output levels firms should remain small and not expand to be cost
competitive
o MES occurs at higher output levels firms should be expand as they need to be large to
be cost competitive
o LRAC is flat small & large firms are equally cost competitive no need for firms to
expand to be cost competitive
Firms may expand due to demand rather than cost reasons output market share
demand & PED P &Q TR and profits

E: Evaluate whether all Singapore based firms aim to grow larger in order to exploit
economies of scale (22-25)

Not all Singapore based companies aim to grow larger some markets have limited EOS
monopolistic competitive e.g. restaurants, boutiques, personalized services
However some of such Singapore based firms do aim to grow larger because they want gain new
sources of revenue e.g. Sake Sushi, Bread Talk
As for electronics and heavy manufacturing firms e.g. Logitech, Creative Technologies, Chartered
Semiconductors, Sembcorp, Keppel Marine etc, EOS is extensive, reaping EOS is arguably
the main reason why they aim to expand

EQ4 on Market Structures

Discuss whether consumers are always better off with monopolistic competition than with a monopoly.
[25]
L1: Define monopolistic competition and monopoly [1-5]

A monopoly refers to a market where barriers to entry are so high that there is only supplier
producing or selling a good that has no close substitutes
Monopolistic competition refers to a market where there are low barriers to entry such that there
are a large number of small firms selling differentiated (similar but not identical) products

2010 TJC JC1 Economics Pre-Promotional Exam Revision Essays Part 1

L2: Explain how the market structures differ in product variety and product innovation [6-14]

Since monopolistic competitive firms sell differentiated products, there is naturally a high degree
of product variety given that each firms product is slightly different from that of another firm and
that there are by definition many firms in the market
A monopoly can be selling a homogenous or differentiated product
o Homogenous product no product variety
o Differentiated products the monopolist may produce a few variants of the same
product as it may be engaging in product proliferation in order to setup artificial
barriers to entry by filling up the product space some product variety
Monopolistic competition lack long run supernormal profits no incentive and ability to engage
in costly R&D
o Little if any technologically related product innovation
o However non technology related innovation would still exists e.g. new restaurants
can come up with recipes or boutiques can invent new clothing designs
Monopoly can enjoy long run supernormal profits
o There is incentive and ability to engage in costly R&D
o However due to the total lack of competition, R&D and innovation is not required for
the firms survival technologically related innovation is likely to be less than if the
market was an oligopoly

L3: Analyze how the market structures differ in terms of price and output. [15-21]

Both firms are price setters MR < AR why?

o For a monopoly it is because the firms demand is equal to market demand
o For monopolistic competition it is because each firms sells differentiated products
Firms in both market set prices at profit max levels where MR = MC but charges a price that is
higher along the corresponding point on the AR curve P > MC
Monopoly has no competitors its products has no substitutes demand is likely to be highly
price inelastic P exceeds MC by a large extent
A monopolistic competitive firm has many competitors its products has many substitutes
demand is likely to be highly price elastic P exceeds MC by a small extent
The degree of consumer exploitation (extent to which P exceeds MC) is likely to be much larger
for monopoly than monopolistic competition consumers generally suffer higher prices and
lower output under a monopoly than under monopolistic competition
However, if there is significant EOS to be reaped MC curve of monopoly is much lower than
the combined MC curve of all the monopolistic firms in the market the effects of higher EOS
may offset that of higher market power consumers may actually enjoy lower prices and higher
output with a monopoly as compared to monopolistic competition

E: Discuss whether consumers are always better off with monopolistic competition than with
monopoly. [22-25]

In markets where EOS and technological innovation is limited, monopolistic competition is

inevitably better for consumers than a monopoly
In markets where EOS is substantial and where technological innovation is essential, monopoly
is arguably better than monopolistic competition
Hence I do not agree that consumers will always benefit more from monopolistic competition as
compared to a monopoly as it depends on the inherent characteristics of the market.