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micro essays

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The Essential Guide to A Levels Economics

The following are sample questions from the book (coming soon!); expect a polished version and many more informative essay outlines when you purchase a copy!

Click to navigate: Q1 Q2 Q3

Question 1

To tackle the problem of obesity, the U.S. government has taken the following actions i) to remove soft drinks machines in elementary schools and ii) also to impose an ad-valorem tax. Soft drinks manufacturers responded by increasing spending on advertising.

Using a diagram, explain how the above measures and response of the soft drink manufacturers might affect the market for soft drinks.             [10]

 

Ad-Valorem Tax

An ad-valorem tax on soft drinks would result in a pivoted shift of the supply curve to the left. Similarly, the removal of soft drinks machines in primary schools would also result in a shift in the supply curve to the left. The accumulated effects can be illustrated by a cumulative leftward shift of the supply curve from SS0 to SS1 in Fig. 1.

Supply of soft drinks should be relatively price elastic since the length of production process is relatively short and the complexity of manufacturing is low. This should be illustrated in the diagram as shown in Figure 1 by the gentle slope of the supply curve.

Price increases but since demand is likely to be price inelastic for soft drinks (low proportion of income), fall in quantity demanded will be less than proportionate.

Advertising

The purpose of advertising is to influence the tastes and preferences of consumers – to make drinking soft drinks look appealing and therefore increasing demand. Demand curve should shift to the right from DD0 to DD1.

This should increase price from P1 to P2 and an increase in output from Q1 to Q2.

Figure 1: Market for Soft Drinks

../Figures/Microeconomics/Figure%207.png


 

Explain the sources of market failure and evaluate the above-mentioned government measures.                                                                [15]

 

The economic rationale for the above measures is to deal with an overconsumption of soft drinks due to negative externalities and imperfect information.

Imperfect Information

Imperfect information exists in the case of soft drinks, whereby many health risks related to the consumption of soft drinks tend to be underestimated by consumers, this results in a divergence between the perceived MPC and the actual MPC as illustrated in Fig. 2. Overconsumption therefore occurs as individuals will consume at Q1 where perceived MPC cuts MSB instead of Q2 where actual MPC cuts MSB.

Figure 2: Imperfect Information                                           Figure 3: Negative Externalities

../Figures/Microeconomics/Imperfect%20Info%20MPC%20Tax.png                  ../Figures/Microeconomics/Negative%20Ext.png

Negative Externalities

Negative externalities also exist in the case of soft drinks, where individuals may only consider their own marginal private costs (cost of the drink, own health risks) and therefore consume at Qm where MPC = MSB (in Fig. 3). The drinking of soft drinks leads to an obesity problem which leads to increased health spending by government and therefore taxpayers may have to pay higher taxes. This leads to the presence of a marginal external cost, which causes MSC to diverge from MPC, resulting in market failure due to overconsumption as consumption would be at Qm instead of Qs, where MSC = MSB.

Government Intervention

Government attempts to address the problem by imposing a tax, forcing individuals to internalise the external costs and therefore reducing consumption to a more socially desirable level. The removal of vending machines in primary schools also addresses the imperfect information as children are more likely to face a problem of not knowing the actual benefits.

These policies may not be very effective, knowing that the demand for soft drinks is relatively price inelastic due to the price being a small proportion of income. An increase in price will lead to a less than proportionate decrease in quantity demanded.

An alternative policy could be to provide divert revenue from such taxes to subsidise healthier drinks to incentivize the drinking of healthier drinks. Removing vending machines from primary schools may have little effect as the school children may still be able to buy soft drinks elsewhere.

An alternative policy would be to perpetuate the spread of the negative health impacts from soft drinks through education campaigns, to bridge the information gap.


 

Question 2

The price of natural fertilisers for organic brown rice production has increased and government-led campaigns to encourage a healthy diet are seeing more consumers switching from non-organic white rice to organic brown rice.

 

Assess the relevance of elasticities of demand and supply in understanding the impact on the expenditure by consumers on non-organic white rice and organic brown rice.                                                                                                                                                                                                [25]

 

 

Natural Fertilisers

Natural fertilisers are a necessary input in the production for organic brown rice. Since the price of natural fertilisers for organic brown rice has increased, the cost of production for organic brown rice will increase, resulting in a fall in supply for organic brown rice. As seen in Fig. 4, the fall in supply from SS0 to SS1 will result in an increase in price from P0 to P1.

 

Figure 4: Increase in price of natural fertilizer on market for organic brown rice

../Figures/Microeconomics/Contraction%20in%20Supply.png

Organic brown rice is likely to be price elastic compared to non-organic white rice since it takes up a larger proportion of income and has a lower degree of necessity. Thus, the increase in price for organic brown rice will likely lead to a more than proportionate fall in quantity demanded, leading to a fall in total expenditure on organic brown rice.

 

Since non-organic white rice is a close substitute for organic brown rice, an increase in the price of organic brown rice will lead to an increase in demand for non-organic white rice, leading to an increase in total expenditure on non-organic white rice.

 

Healthy Living Campaigns

The healthy living campaigns have caused changes in tastes and preferences for non-organic white rice and organic brown rice. More people may now prefer organic brown rice to non-organic white rice. This will lead to an increase in demand from D0 to D1 for brown rice as seen in Fig. 5 Correspondingly there will be a fall in demand from D0 to D1 for white rice as reflected in Fig. 6.

 

Figure 5: Healthy living campaigns affecting demand for brown rice

 

../Figures/Microeconomics/Rise%20in%20Deamnd.png

 

Figure 6: Healthy living campaigns affecting demand for white rice

 

../Figures/Microeconomics/Fall%20in%20Demand.png

 

Elasticities concepts are not relevant here in explaining the changes

The above is a simple change in demand

 

Combined impact on TE for organic brown rice

Depends on the extent of the shift.

If increase in DD > fall in supply, TE increases

If fall in supply > increase in DD, TE decreases

 

Combined impact on TE for non-organic white rice

Depends on whether increase in DD > fall in DD


 

Question 3

Explain the type of market structure that supermarkets in Singapore are likely to operate in.                                                                                     [10]

 

Oligopoly is a state of limited competition, in which a market is shared by a small number of producers or sellers.

Market is dominated by a few large firms
Dairy Farm which owns Cold Storage, Shop & Save, Giant
Sheng Siong
NTUC Fairprice
Prime

Presence of high barriers to entry
High start-up cost due to the need to stock up on inventories, purchase of machinery, rental of locations and hiring of staff
The above-mentioned are all extremely costly in Singapore

Firms engage in non-price competition
Improved shopper experience by setting up booths providing free samples
Advertising (TV Shows)
Promotions

Presence of Economies of Scale
Existing firms may be producing at a scale that allows them to purchase their products at very low costs due to significant bargaining power
New firms entering the industry may find it hard to compete


 

Discuss whether price competition is the ideal business strategy for supermarket chains.                                                                                           [15]

Price competition not the ideal strategy

Firms in an oligopolistic market structure are mutually interdependent due to the concept of price rigidity. This results in a kinked demand curve as illustrated in Fig. 7. If any firm were to decrease price (when they engage in price-competition), all the other firms will follow suit and therefore they will operate at the segment where demand is inelastic and therefore quantity demanded will increase less than proportionately and lead to a fall in revenue

Furthermore, Supermarket chains carry mostly necessities such as staple foods, daily essentials, toiletries etc. Such goods are price-inelastic, and therefore if they engage in price competition and cut prices

Non-price competition should be the primary strategy

Due to price rigidity, the best solution would be for firms not to engage in price competition. Firms can instead engage in non-price competition to compete for market share to increase total revenue and therefore profits.

Non-price competition can include advertising, where firms advertise to increase brand loyalty to attract consumers to switch to buying from them or through product innovation / better service.

Figure 7: Kinked Demand Curve

../Figures/Microeconomics/Kinked%20Demand%20Curve%202.png