Kami Export - S&R Answers - Market Structure - H2 Final

Unit 3 Market Structure - Suggested Questions for H2 Economists (Week 10 – Term 4
Week 2)
Basic Questions for Market Structure
(a) Production & cost
1. Distinguish between fixed and variable costs. [6]
2. Using appropriate examples, distinguish between internal and external economies

of scale. [10]
3. Explain 2 sources of internal diseconomies of scale. [6]
4. Define external diseconomies of scale and explain how it may arise. [4]
(b) Objectives of firms
1. Explain how do firms, in theory, determine price and output level. [8]
2. Evaluate if firms in reality practise this condition. [4]
3. Explain the meaning of sales revenue maximisation. [4]
4. Evaluate if sales volume maximisation will contribute to profit maximisation for

firms. [6]
5. Evaluate if firms still can earn supernormal profits when they practise profit-
satisficing. [6]
6. Explain the strategies a firm may undertake to deter the entry of new firms. [6]
7. With the aid of a diagram, explain how a firm achieves the objective of market
share dominance. [5]
Tampines Meridian Junior College

Economics Department – JC1 Stretch and Reach Programme Page 1
(c) Perfect competition
1. Define a perfectly competitive industry [2]
2. Explain the key features of a perfectly competitive market. [5]
3. Explain 3 advantages and 3 disadvantages of a perfectly competitive market

structure.
Advantages Disadvantages
4. Explain the adjustment process for a perfectly competitive firm earning supernormal
profits to long run equilibrium [4]
(d) Monopoly
1. Define a monopoly. [2]
2. Explain the key features of a monopoly. [5]
3. Explain what is meant by price discrimination. [2].
4. Explain clearly the conditions for successful and profitable price discrimination. [6]
5. Explain the 3 advantages and 3 disadvantages of a monopolistic market structure.
6. Explain why the monopoly is able to continue earning supernormal profits in the long
run. [2]
7. Explain what a monopoly will do to preserve its supernormal profits. [5]

(e) Oligopoly
1. Explain the meaning of five firm market concentration ratio. [2]
2 Define an oligopoly. [2]
3. Explain the key features of an oligopoly. [5]
4. Explain 3 advantages and 3 disadvantages of an oligopolistic market structure.
5. Explain how a cartel works. [4]
6. Explain the conditions in order for the formation of cartel to be successful. [4]
(f) Additional Questions on Market Structures
1. Draw and explain the shape of the demand curve for a perfectly competitive firm, a
monopolistic firm, a monopolistic competitive firm and an oligopolistic firm
Firm Shape/Slope Diagram of the demand Explain the reasons

(PED) of DD curve for the shape of the
curve demand curve
Perfectly
competitive firm
Monopolistic firm
Oligopolistic firm
2. Explain the type of market structure in which a 5-star luxury hotel is likely to operate
in Singapore. [3]
3. Explain how the following strategies can help a firm to increase its profits:
(a) Product development for monopolistic or oligopolistic firms

(b) Use of automation and technology to reduce costs for monopolistic or oligopolistic
firms
a) Production & cost
1. Distinguish between fixed and variable costs. [6]
Reference to CSQ Skills Package:

Similar to Command word: ‘Compare’ [Pg 19]
Requirements: State a similarity and difference between variables
Fixed costs are costs which do not vary with the level of output produced. It occurs
when fixed factors i.e. land to build the factory or initial machines used in this case
which cannot be easily varied within a period of time. Variable costs, on the other
hand, vary directly with output. Examples are labour costs whereas the firm
increases the size of production, the firm will hire more labour and hence incur an
increase in variable costs. Other examples are like costs of raw materials (inputs)
and costs of utilities (electricity/water used to power up the factory production etc).
Fixed costs are constant and independent of changes in the level of output. In fact,
even when output is zero, fixed costs will still be incurred. An example can be
advertising costs that a firm may have undertaken to highlight the high quality
assurance in their products. However, as for variable costs, the firm only incurs them
as production starts.
Fixed costs is only present in the short run, where fixed factor exists. In the long run,
there is no fixed factor hence a firm incurs zero fixed costs. However, variable costs
are present in both short and long run periods.
2. Using appropriate examples, distinguish between internal and external

economies of scale. [10]

Introduction
 EOS can be divided into internal and external EOS.
 [Comparing Definitions] A firm experiences internal economies of scale if
its average cost per unit of output falls due to the scale of production
increasing.
 On the other hand, a firm experiences external economies of scale if its
average cost at a particular output falls due to expansion of the industry.
Development
 [Comparing Diagrammatically] Internal economies of scale are
represented by the movement along the falling portion of the U-shaped LRAC

curve. As output increases from Q1 to Q2, average costs falls from C1 to C2,
as shown in Figure 1.
 However, external economies of scale are represented not by a movement
along, but instead by a downward shift of LRAC curve from LRAC1 to LRAC2
as shown in Figure 1. This means that at every output level, the average costs
of the firm have fallen. For example, a firm producing at output Q1 may now
face a lower average cost of C3 instead of C2 due to the expansion of the
industry as seen in Figure 1.
Figure 1
Internal economies of scale may be due to the following: technical, financial,

marketing, risk-bearing and managerial economies of scale.
 [example 1] For example, a firm such as Old Chang Kee is able to lower the AC
of producing each curry puff due to technical economies of scale as it
increases its output.
 ↑variable factor such as labour  allow for specialisation and division of labour
 Lower skilled workers are easily trained and quickly become proficient through
constant repetition of a task  cashiers or cooks will become more productive
(↑output per man hour) at their task  decrease labour costs  thereby reducing
unit cost.
 [example 2] Furthermore, Old Chang Kee may enjoy marketing EOS due to an
increase in output.
 Suppliers may offer discounts to firms in an attempt to secure large orders when
firms purchase ingredients in bulk decrease in cost of raw materials  lowers
the average costs of production.
On the other hand, external Economies of scale may be due to the geographical
concentration of firms resulting in benefits such as development of industrial
amenities and a better transport system.
 For example, the petrochemicals companies such as ExxonMobil, Shell and BP
operate in a concentrated geographical area on Jurong Island, they are able to
enjoy cost savings from the development of industrial amenities and
infrastructure such as better transport system.
 [example 3] As the industry expands  Supporting firms catering to the needs
of the industry will be set up such as water and power supplies  access these
utilities cheaply  lower unit cost for the whole industry.
 [example 4] As the industry expands  a transportation system will be set up
by the government  ↓transport cost of goods and raw materials  lower unit
cost for the whole industry

Conclusion
 Therefore, the primary difference lies in the source of the cost advantage i.e.
internal EOS is due to firm’s expansion, external EOS to industrial expansion.
3. With the aid of a diagram, distinguish between internal and external
diseconomies of scale. [6]

Cost
LRAC2
LRAC1
C3
C2
C1
C3
C3
O
C3
Figure 2 Output
Q1 Q2
[Comparing Definitions]
 A firm experiences internal diseconomies of scale if its average cost per unit
of output rises due to the scale of production increasing.
 On the other hand, a firm experiences external diseconomies of scale if its
average cost at a particular output rises due to expansion of the industry.
[Comparing Diagrammatically]
 Internal diseconomies of scale are represented by the movement along the
rising portion of the U-shaped LRAC curve. As output increases from Q1 to Q2,
average costs rise from C1 to C2, as shown in Figure 2.
 However, external diseconomies of scale are represented not by a
movement along, but instead by a upward shift of LRAC curve from LRAC1 to
LRAC2 as shown in Figure 2. This means that at every output level, the
average costs of the firm have risen. For example, a firm producing at output
Q1 may now face a higher average cost of C3 instead of C1 due to the
expansion of the industry as seen in Figure 2.

4. Explain 2 sources of internal diseconomies of scale. [5]

Similar to Command word: ‘Explain what is meant’ [Pg 21]
Requirements: Elaborate what the terms or statements mean using economic
terms & analysis
Internal diseconomies of scale are the cost disadvantages a firm experiences as it

increases its scale of production. When a firm becomes too large, its average cost
of production rises as its scale of production increases.
High cost of monitoring and management

Management problems of co-ordination may appear as the organisation of the firm
becomes too big. As a firm gets increasingly too big, it becomes difficult for top
management to co-ordinate and monitor all operations, thus inefficiency may creep
in, increasing average cost of production. This is especially so for large firms with
complicated production processes across several plants in different locations and
countries.
Financial Diseconomies
This occurs when big firms become too large and borrow too heavily (as it requires
a lot of capital to finance expansion). It may be possible for the firm to obtain such
finance only from sources which charge higher rates of interest, thereby increasing
average cost of production.
5. Define external diseconomies of scale and explain how it may arise. [5]

Similar to Command word: ‘Define’ [Pg 17] and ‘Explain how’ [Pg 22]
Requirements: Provide the full definition with the correct economic terms, along
with assumptions where relevant or Elaborate on how a factor impacts an area that
the question has stated. OR Elaborate on how a concept is shown or illustrated in
a particular context
External diseconomies of scale are the cost disadvantages a firm experiences as

the industry expands as a whole. When an industry becomes larger, the average
cost of production of the firm at every level of output rises.
Such diseconomies result primarily from the geographical concentration of firms in

the industry.
 Shortage of industry-specific resources resulting in higher factor prices.
As an industry increases in size, the increased demand for factors of production
leads to a shortage of the factors that result in higher factor prices and thus
increases firm’s cost.
 Strain on physical infrastructure: overcrowding & congestion

Problems of traffic congestion could mean loss of man-hours in business. Over-
crowding, noise as well as air pollution arising from geographical concentration
of firms may force government to impose taxes and fines. These eventually lead
to higher unit cost of production.
(b) Objectives of firms
1. Explain how do firms, in theory, determine price and output level. [8]

Similar to Command word: ‘Explain how’ [Pg 22]
Requirements: Elaborate on how a factor impacts an area that the question has
stated. OR Elaborate on how a concept is shown or illustrated in a particular
context
Introduction:
Explain profit maximizing condition:
A firm is a basic decision-making unit. A firm will seek to achieve as high a level of
profit as possible. Profit is the difference between the total revenue received from
selling the good and the total cost of producing the good. Profit is maximised i.e.
the greatest positive difference between total revenue and total costs is derived
when Marginal Cost (MC) = Marginal Revenue (MR)
Here, MC or marginal cost refers to the additional cost incurred from producing one
more unit of output while MR or marginal revenue refers to the additional revenue
gained from selling that extra unit.
Development: Explain the derivation of the Profit Maximizing Condition
Explain why profit-maximising output occurs when MC = MR.
Figure 2
Cost/Revenue ($)
AC
MC
a
D=AR
MR
b c
From the diagram, the firm would determine the price and output to maximize
profits by equating MC=MR, where MC cuts the MR from below.
At output 0Q1 where MC < MR, the firm can increase its profits by expanding
production, since MC < MR, then producing one more unit of output adds more to
revenue (aQ1) than to cost (bQ1). Total profit will increase by ab if production of
the Q1th unit is undertaken. Hence by the marginalist principle: the addition to
revenue will be higher than the addition to costs when the firm produces from Q1
 Q levels of output as seen from the diagram above.
At output 0Q2, MC>MR, then producing one more unit of output adds more to cost
(cQ2) than to revenue(dQ2). Hence, the firm should not undertake the production
of Q2th unit in order to increase total profits. By the marginalist principle, the
addition to revenue will be lower than the addition to costs when the firm produces
from Q  Q2 level of output as seen from the diagram above.
Thus, the profit maximizing output will be up to Q units of output  where addition
to revenue = addition to costs when undertaking Qth unit of production. Profits
cannot be increased further by changing its output level and the firm has achieved
maximum profits.
Explain how the firm determines its profit maximizing price
Figure 3
Cost/Revenue ($)
AC
MC
P X
Z Y
D=AR
MR
Economics Department – JC1 Stretch and Reach Programme Output Page 9
0 Q
At the profit maximizing output, Q, the price is ‘P’  level of price consumers are
willing and able to pay as obtained from the demand (AR) curve. The profit made
by the firm is maximized at PXYZ at the given AC curve.
Conclusion:
Firms maximize their profits based on the marginalist principle.
2. Evaluate if firms in reality practise this condition. [4]

Similar to Command word: ‘Evaluate’ [Pg 27]
Requirements: Give your verdict as to what extent a statement is true, or to what
extent you agree with them. Provide a balanced argument, well-supported by
economic theories & evidences. Come to a conclusion, basing your decision on what
you judge to be the most important and justify accordingly.
[Evaluation 1: Lack of information & violation of ceteris paribus assumption]
In reality, most of the firms do not have perfect information to identify the profit
maximizing price and output and thus are not able to focus on profit maximisation.
This is because they lack the ability to determine their demand curve as conditions
affecting demand and supply are continuously changing in reality due to many other
factors and also, how competitors may behave in response to their actions.
Therefore, due to lack of accurate information on cost and revenue curves, some
firm would instead practice cost plus pricing where firms would simply estimate
their long run average cost and then add a profit margin. This is especially true for
smaller firms who may not be able to afford expensive market research.
[Evaluation 2: avoid unwanted attention from the government] Firms may also
choose not to maximize profits to avoid unwanted attention from the government
and business rivals. High profits attract unwanted attention from the government,
concerned that the firm may be exploiting consumers, or from other firms keen to
acquire profitable assets.
3. Explain the meaning of sales revenue maximisation. [4]

terms & analysis

 Sales managers and commission-based employees, whose incomes are
dependent on the total revenue of the firm, might choose to maximise revenue
rather than profits.
 Managers’ actions may be influenced by the level of sales revenue. High sales
revenue can make it easier for a firm to raise loans from bank.
 If a firm is aiming to achieve sales revenue maximization it should produce where
marginal revenue is zero since at this point total revenue will be maximum.
 As shown in figure 4, the sales maximizing firm will produce output OQ2.
Figure 4
4. Evaluate if sales volume maximisation will contribute to profit maximisation

for firms. [6]

Sales volume maximisation is achieved when total revenue = total cost. In other
words, a firm is selling as much as it can without making a loss. At the sales
maximisation output, there are normal profits only and no supernormal profits/loss.
Firms choose a sales volume maximisation objective as they want to achieve a

rapid growth of market share to dominate the industry. They will produce the
maximum output subjected to normal profits where average revenue equals
average cost. Figure 5 shows a sales volume maximizing firm will produce at OQ3
and charge price OP3.
Figure 5
Price/Cost/Revenue

MC
AC
P3
Maximum sales at OQ3

MR AR
subjected to normal profit
O Q3
Qty
Sales volume maximisation, profit maximization and the interests of managers and
shareholders may conflict, especially in the short run.
 To increase sales volume a firm may spend a large amount on advertising

and/or cut prices, which may initially lower profits.
 Shareholders are likely to want a high proportion of profits distributed as
dividends, whereas managers, concerned about growing the firm, will want to
reinvest most of the profits in equipment and buildings.
However, in the long run the two objectives may be compatible and both
shareholders and managers may be happy if the actions taken in pursuit of sales
maximisation increase market share and raise long-run profits.
5. Evaluate if firms still can earn supernormal profits when they practise profit-
satisficing. [6]

 Rather than trying to maximize profits, managers aim for a profit level that will
keep stakeholders happy.
 For example, The Body Shop has objectives which are based on their beliefs
that their beauty and cosmetics products are ethically produced and were not
tested on animals. In this case, the managers of The Body Shop are aiming for
a profit level that keep shareholder happy rather than trying to maximize profits.
 The managers are reluctant to accept the increased risks and pressures
associated with fiercely competitive policies, or because they are seeking to

satisfy not only shareholders but also other stakeholders such as workers,
consumers, suppliers, the local community and environmentalists.
 These groups may have different objectives: consumers want low prices and
high quality; workers want high wages, job satisfaction and security; suppliers
want a high price; the local community want employment but an absence of
congestion; and environmental groups want a clean environment and the
conservation of flora and fauna.
 In this way, the firm may try make just sufficient profits for shareholders and at
the same time fulfil its social responsibility by producing products that
environmentally friendly. As a result, the cosmetic company is likely to be
seeking a profit level that enables it to satisfy its shareholders but at the same
time, allow it to produce environmentally friendly goods to satisfy its
stakeholders.
Evaluation
This objective may appear to conflict with profit maximization in the short run but
may be compatible in the long run.
 For example, showing concern for the environment, e.g. by not selling genetically
modified food or diverting a pipeline away from an area of natural beauty, is likely
to raise a firm’s costs.
 However, it may also provide it with good publicity and may increase demand for
its products  long run revenue may rise by more than costs  profit increase.
Conclusion
Profit satisficing, far from conflicting with profit maximization, can contribute to it.
 [Similarly, raising workers’ wages will increase costs in the short run but may
reduce labour costs in the long run if the higher wages increases labour
productivity and reduce labour turnover.]
6. Explain the strategies a firm may undertake to deter the entry of new firms. [4]

terms & analysis
Product Development (non-price strategy):

To prevent new firms from entering the market, existing firms may adopt strategies
such as product development. New firms are deterred from entering the market as
they may not have sufficient capital to invest in producing similar products.
Limit pricing (price strategy):

Limit pricing is practised where prices are set with the aim of discouraging potential
rivals from entering the market. The firm (monopoly) will deliberately keep its prices
low, hence restricting the size of its profits so as not to attract potential entrants. For
instance, with reference to figure 6, the monopolist can reduce its price from the
profit maximising level P1 to P2 (any price below profit-maximising price P1),
reducing the size of its supernormal profits to a smaller amount from P1C1ba to area
P2C2dc. This discourages potential rivals to enter, allowing the monopolist to
maintain its monopoly position.
Figure 6
7. With the aid of a diagram, explain how a firm achieves the objective of market
share dominance. [4]

Requirements: Elaborate on how a concept is shown or illustrated in a particular
context
In an attempt to increase the firm’s market share and hence market power, decisions
could be made with the aim of driving rival firms out of the market. For example, the
firm could engage in predatory pricing, which involves the firm temporarily pricing
its product below its average cost (C1) at P1 (Fig. 7) in order to drive new entrants
out of business. The firm will make a loss of area C1P1ba now. Once the predator’s
rivals drop out of the market, the firm’s demand rises to AR2. It can then restrict
output and charges a monopoly price (P2), well above its production cost (C2). It
makes supernormal profit of area P2C2dc. This will be a profitable strategy if the
firm can charge the monopoly price for a long period to offset the losses it
experienced while driving its rivals out of business.

Figure 7
(c) Perfect competition
1. Define a perfectly competitive industry [2]

Similar to Command word: ‘Define’ [Pg 17]
with assumptions where relevant
Perfect competition is a market structure whereby many small firms produce a

homogenous product and where there are no barriers to entry or exit to the market.
2. Identify 3 key features of a perfectly competitive industry

 Free entry into and exit out of the industry
 Homogeneous product
 Large number of sellers and buyers
3. Explain the key features of perfectly competition. [5]

terms & analysis
Link features to behaviour(pricing and output) & performance(long run profits)
 Explain impact of features (no of firms & type of product) on the firm’s demand
curve (shape), hence pricing & output behaviour (3m)
 Explain impact of feature (type of BTE) on the long-run profits that the firm can
earn (2m)

An example of a perfectly competitive market would be the agriculture goods market
for onions, where there are many small farms, each producing an insignificant
share of the market. Therefore, any change in the farmer’s output will not affect
industry supply and influence market price. Each farmer can only take the market
price as determined by the mkt demand & supply forces  is a price taker  hence
each farmer faces a perfectly price elastic DD curve for his onions. With reference
to the figure below, If a farmer raises its price of onions there will be no demand as
consumers turn to other sellers since the onions produced by one farmer is
indistinguishable(i.e. they are homogenous) from another and thus, there exists
perfect substitutes for one another. Firms will have no incentive to lower the price
because doing so will be less profitable.
Figure 6
Price and output are determined by the profit maximising condition of MC=MR. If
MC<MR, producing 1 more unit adds more to revenue than to cost, firm should
continue production to gain additional profits (briefly explain profit max condition).
For the PC firm, AR=MR=P. From Figure 6, output is determined where MC cuts
MR, when MC is rising, and the equilibrium output level is Q and equilibrium price
P.
In the short run, in the agricultural market such as onions, free entry and exit is
possible as long as farmers have available land to grow onions for sale in the market.
Exit is easy with farmers diverting resources away from onion production to other
uses.
Due to the absence of barriers to entry, when the farmers earn supernormal profits
(area PCDE as seen in figure 6), new farmers will being attracted to the supernormal
profits earned can easily enter the industry. As new farmers enter the industry, the
industry SS curve of onions will shift to the right from S to S1 causing price of onions
to fall until AR = LRAC where only normal profit is made. There is no incentive for
new farmers to enter the market. Long run equilibrium is attained where the firm will
be producing at output Q1 and charging a price of P1, as illustrated by In Figure 7
below. The price charged is just enough to cover AC. Hence the farmer can only
earn normal profits in the long run.

Figure 7
4. Explain 3 advantages and 3 disadvantages of a perfectly competitive market

structure.

terms & analysis
Allocatively Efficient  efficient Lack of BTE unable to retain
allocation of resources right goods supernormal profits to carry out
produced at the right amounts. product and process R&D Not
dyanamically efficient.
Productively Efficient  Good Inequity since distribution of goods

produced at the minimum resource produced is based on those who are
cost by adopting the least cost willing and able to pay which is in turn
method of production. based on “money votes”
Produce at minimum LRAC firms Lack of variety of goods

are using the least cost scale of
production and operating with
optimum capacity Attain minimum
efficient scale (MES)
5. Explain the adjustment process for a perfectly competitive firm earning

supernormal profits to long run equilibrium [4]


terms & analysis
Supernormal profits serve as incentives for entry of new firms. Lack of barriers to
entry permits new firms to enter the industry, resources move in and the industry‘s
supply increases. The market supply curve shifts from S to S1 and the market price
falls from OP to OP1.
The firm’s demand curve falls to D1=AR1=MR1 since the firm is a price taker. The
new equilibrium price and quantity is OP1 and OQ1 respectively. Profit falls from
the shaded area (supernormal profits) to zero economic profits (normal profits). The
supernormal profit is competed away.
As long as the firm is making supernormal profit, changes continue until all firms in
the industry earns normal profits. There is no incentive for new firms to enter
industry. The firm is in long run equilibrium.
Figure 8
(d) Monopoly
1. Define a monopoly. [2]

Requirements:Provide the full definition with the correct economic terms, along with
assumptions where relevant
A monopoly is where a single firm controls the whole supply of a product which has
no close substitutes.
2. Identify 2 key features of a monopoly.

Similar to Command word: ‘Identify’ [Pg 17]
Requirements: State
 Very high barriers to entry

 No close substitutes
3. Explain the key features of a monopoly. [5]

terms & analysis
Link features to behaviour(pricing and output) & performance(long run profits)
 Explain impact of features (no of firms & type of product) on the firm’s demand
curve (shape), hence pricing & output behaviour (3m)
 Explain impact of feature (type of BTE) on the long-run profits that the firm can
earn (2m)
Taking the context of a monopoly, where there is only 1 single firm producing a
unique product for the entire market. For instance, FIFA, who is the sole organiser
and distributor of world cup broadcasting rights. There are formidable barriers to
entry due to its specialised expertise and knowledge in organising the world cup
matches.
Due to the lack of alternative suppliers, a monopolistic firm has very strong market
power and as such, is a price setter and is able to raise price by restricting output.
Such a firm would therefore face a downward sloping demand curve that is relatively
price inelastic given the lack of substitutes available.
As seen from the figure below, output is determined at the profit maximising level,
where MC=MR, when MC is rising. As monopolists are able to raise price by
restricting output, they are able to charge a high price at P1 and quantity at Q1.

Figure 9
Existence of strong barrier of entry enables FIFA to earn supernormal profits (Area
P1EGC) even in the long run as strong barriers to entry deter new firms from entering
the market and competing away the supernormal profits.
4. Explain what is meant by price discrimination. [2]

terms & analysis
Price discrimination refers to the practice of selling the same product to different
customers at different prices even though costs are the same.
5. Explain clearly the conditions for successful and profitable price

discrimination. [6]

Similar to Command word: ‘Explain the factors’ [Pg 25]
terms & analysis
2marks for each condition explained
Example used throughout the answer: popular band performing in a concert
Condition 1: Market Imperfections exist.

The firm must be able to set its price.
Firms practicing price discrimination must have market power to set price.
Here, the firm has monopoly power because it is the sole provider of live concert
music from the band.

Condition 2: Differing price elasticities of demand.
Demand elasticity must differ in each market.
The firm will charge Market B the higher price where demand is less price elastic
and Market A at a lower price where demand is more price elastic.
The price elasticity of demand may differ between consumers who are very loyal
fans of the band. To them, it is like a necessity to be up close and personal with their
idols in the band. Such fans would probably have a demand that is price inelastic for
front row seats.
On the other hand, there are some consumers who are watching the concert as
merely a form of leisure/entertainment and therefore, it is not as necessary for them
to obtain front row seats. Such fans would probably have a demand that is price
elastic for front row seats.
Condition 3: Resale or Seepage is not possible

Concert goers holding on to cheap tickets must not be able to change their seats to
more expensive areas.
Here, the markets can generally be regarded as separable because consumers who
pay for the relatively cheaper tickets of seats in poor locations will not be able to sell
their tickets as more expensive tickets in good locations. Printing of seat number
and simple colour coding of tickets ensure this.
Holders of cheaper ticket can be prevented from changing their seats to the more
expensive locations. Different entrance for different areas, zoning in the venue with
security guards checking tickets, the fact that the venue would be full with few empty
seats for seat switching, can all ensure that the markets are kept separated.
Note:
However, there can be exceptions. For example, certain area (like the VIP section)
might have better seats and facilities than the normal areas thus it makes sense for
the price of those special areas to be more expensive due to the higher cost incurred.
In this case, it may not be PD if the cost differences are significant enough to justify
for the price differences.

6. Explain the 3 advantages and 3 disadvantages of a monopolistic market
structure.

Requirements: Identify and explain the factors
Presence of strong BTE able to P>MC at the level of output produced
retain supernormal profits to carry out  Allocatively Inefficient  inefficient
product and process R&D  allocation of resources right goods
Dynamically efficient. not produced at the right amounts.
Product variety Produced at higher price and lower

output
Economies of scale Unequal income distribution

especially when there is a lack of
contestability resulting in firms using
supernormal profits earned to give out
dividends to shareholders rather than
to channel them to product and
process R&D
7. Explain why the monopoly is able to continue earning supernormal profits in

the long run. [2]

Similar to Command word: ‘Explain why’ [Pg 22]
Requirements: Elaborate on the reason(s) using economic analysis
In the short run when the monopolist earns supernormal profits, new firms are
attracted to enter, however, they are unable to enter due to the significant barriers
to entry. For example, DeBeers was a monopoly in the diamond industry for a long
time because DeBeers controlled most of the diamond mines. As a result, new firms
cannot enter the diamond industry because new firms cannot obtain the raw
diamonds for processing and polishing. Since the new firms cannot enter, the
demand curve and the MR curve will not be affected and supernormal profits can
persist in the long run.
This is the opposite of perfect competition when firms can enter in the long run and
erode away the profits of existing firms. Supernormal profits of the monopoly will
persist and not be competed away.
8. Explain what a monopoly will do to preserve its supernormal profits. [5]

Requirements: Elaborate on how a factor impacts an area that the question has
stated.
In the short run, the monopoly may seek to strengthen the barriers to entry. For
example, the diamond monopoly may see to increase the amount of diamond mines
they own. By doing so, new firms cannot enter the industry. In the long run, firms
can then ensure that supernormal profits persist in the long run.
Apart from strengthening barriers to entry, monopolies may also choose not to
maximise profits. Many governments or regulators view firms with more than 25% of
market share as monopolies. Due to the monopolies earning excessive profits, the
government often seek to control or regulate the monopolies as they view it as an
inequity issue.
The governments also may want to regulate because the monopoly is allocatively
inefficient selling an output where the monopoly price is above marginal cost. The
price is the value which consumers place on the last unit of good and the marginal
cost is the cost of producing the last unit. When the consumers value the last unit
more than the cost of producing it, the good is under-producing. The government
may seek to regulate it such as nationalise it which is to take control of the firm so
that they reduce the underproduction. Hence, the monopoly may want to produce at
a lower price and higher quantity so that the underproduction is not as severe and
avoid the authorities’ attention.
By producing at a lower price than Pp, quantity will increase, the profits which is total
revenue minus total cost is also smaller. Hence profit is not as excessive.
The quantity is also higher and price is closer to marginal cost and hence the
monopoly is less inefficient. Since profit is not as excessive and the allocative
inefficiency may not be large, monopoly will be able to avoid being regulated by the
government and therefore they can preserve their supernormal profits in the long
run.
(e) Oligopoly
1. Explain the meaning of five* firm market concentration ratio. [2]

terms & analysis
Five* firm concentration ratio means the market share held by the five* largest firms
in the industry, i.e. a five* firm concentration ratio of more than 50% means the five*
largest firms in the industry have more than 50% of the market share.

Market Concentration Ratio = output of 5* largest firms x 100%
total industry output
*Note: depending on context, it might be more appropriate to calculate three/four/six

firm market concentration ratio
2. Define an oligopoly. [2]

with assumptions where relevant
An oligopoly is a market structure whereby a few large interdependent sellers

dominate, selling a homogenous or differentiated product and where there are
significant barriers to entry or exit to the market.
3. Identify 3 key features of an oligopolistic industry.

Similar to Command word: ‘Identify’ [Pg 17]
Requirements: State
 Mutual interdependence between firms

 Substantial barriers to entry
 Standardised or differentiated product
4. Explain the key features of an oligopoly. [5]

terms & analysis
However, in an oligopolistic market, there are substantial BTE (e.g. the need to
obtain licences in order to produce goods and services in the telecommunication
industry.) Licenses are exclusive permits to produce that firms own.)  Few large
firms with significant market power (E.g. 3 large firms providing mobile phone
services in Singapore; Singtel, M1 and Starhub)  such firms are also rival
conscious and are mutually interdependent  price setter  downward sloping
demand curve
Homogeneous or differentiated product
 Differentiated through branding, packaging and aggressive advertising (E.g. the

telecommunication firms offer different perks to customers for staying “loyal” to
the company)

Impact on price and output decision would depend on firm’s behaviour:
compete or collude
a) The mutual interdependence between oligopolists may also lead to them to

compete to gain a larger share of industry profits for themselves
A telecommunication firm is reluctant to raise its price above P1, as it expects its
rivals will not follow suit as they could gain customers from the firm. Hence, the
increase in price will bring about a more than proportionate fall in quantity
demanded. On the other hand, should the firm lower its price below P1, he would
expect his rivals to follow suit so as not to lose customers to the firm. Thus, a fall in
price would bring about a less than proportionate increase in quantity demanded.
Figure 12
This gives rise to the kinked demand curve where the demand curve is relatively
price inelastic below the existing price level P1 and relatively price elastic above the
existing price level.
Similarly, a profit maximising oligopolistic firm would be producing at MC=MR as

shown in Figure 1. Firm’s output is at Q1 and price at P1.
[optional] However, prices remain rigid at P1 if costs vary between MC1 and MC2. For
example, given an increase in MC from MC1 to MC2, firm’s price and output would
remain at P1 and Q1 respectively.
Or
b) The mutual interdependence between oligopolists will may lead to firms to

collude to maximize industry profits (cartels or price leadership)

On the other hand, oligopolistic firms producing homogeneous products may also
choose to collude to restrict competition among themselves and maximize their
combined profits. Examples of collusion include cartels and price leadership.
A cartel is a formal collusive agreement whereby firms will work together and act like
a profit maximising monopoly. In Figure 13, profits are maximised at output OQ1
where Industry MR = Industry MC. The corresponding price is OP1.
A cartel may decide to fix its prices or set output quotas. OPEC, an example of cartel
ensures the stability of oil prices by controlling oil supply through the setting of
production quotas. Each member will be allocated an output quota to supply. The
sum of the quotas of all the members in the cartel must add up to OQ1 so that
industry profits are maximised.
Impact on price and output determination in LR:
Unlike MC firms, the presence of substantial BTE enables an oligopolistic firm to

retain its supernormal profits in the LR. Thus, the firm’s pricing and output decision
would remain at P1 and Q1 respectively. In the long run, an oligopolist will remain in
business only if he can at least make normal profit.
Figure 13

5. Explain 3 advantages and 3 disadvantages of an oligopolistic market
structure.

Requirements: Identify and explain the factors
Presence of strong BTE  able to P>MC at the level of output
retain supernormal profits to carry out produced Allocatively Inefficient 
product and process R&D inefficient allocation of resources
Dynamically efficient. right goods not produced at the right
amounts.
Product variety Produced at higher price and lower

output as compared to PC.
Economies of scale Unequal income distribution

especially when there is a lack of
contestability resulting in firms using
supernormal profits earned to give out
dividends to shareholders rather than
to channel them to product and
process R&D
6. Explain how a cartel works. [4]

context
A cartel is a formal collusive agreement. All firms in a cartel will coordinate their
activities so as to maximise industry profits, behaving as if they were a monopoly.
Since cartel members explicitly agree to work together and behave like a monopoly,
the model used to analyse the price and output decisions of a collusive oligopoly is
the same as that used to analyse monopoly. This is illustrated in Figure 1.

In Figure 1, profits are maximised at output OQ1 where Industry MR = Industry MC.
The corresponding price is OP1.
If the cartel decides to fix prices, it should fix the price at OP1 so that industry profits
are maximised. Alternatively, if the cartel decides to control production through the
setting of quotas, each member will be allocated an output quota to supply. The sum
of the quotas of all the members in the cartel must add up to OQ 1 so that industry
profits are maximised.
The firms in a cartel may decide to either fix prices or set output quotas. A quota set
by a cartel is the output that a given member of a cartel is allowed to produce under
a production quota or sell under a sales quota. An example of a cartel is OPEC, the
Organization for Petroleum Exporting Countries, which was set up in 1960 and
currently consists of 14 oil-producing countries. Its objective is to ensure the stability
of oil prices by controlling oil supply through the setting of production quotas.
7. Explain the conditions in order for the formation of cartel to be successful. [4]

terms & analysis
 The members must adhere to their production quota

Many cartels do not last very long due to disputes among members and the strong
incentive to cheat (i.e. cutting prices below the agreed price or exceeding assigned
quotas) by individual members. For example, given the high price that the cartel is
able to achieve, individual members will be tempted to expand their output beyond

their quota. By cheating on the agreement (producing a little bit more), they are able
to further increase their profits.
 The cartel must have the potential for monopoly power.

Cartels often break down when non-cartel members have significant control over the
market supply of the good. This means that all efforts by the cartel members to
restrict supply to push up prices only serve to benefit the non-members, leaving
them with a greater market share.

(f) Additional Questions on Market Structures
1. Draw and explain the shape of the demand curve for a perfectly competitive firm, a
monopolistic firm, a monopolistic competitive firm and an oligopolistic firm
Firm Shape/Slope Diagram of the demand Explain the reasons

(PED) of DD curve for the shape of the
curve demand curve
Perfectly PED = infinity  Lack of BTE

competitive  Goods are perfect
firm substitutes of one
another
Monopolistic Demand curve  Very strong BTE

firm is relatively price  Unique product
inelastic PED<1
Firm produces
on the elastic
portion of the
inelastic
demand curve.
Oligopolistic Kinked demand  Mutual

firm curve interdependence
(assuming a
competitive
oligopoly)
2. Explain the type of market structure in which a 5-star luxury hotel is likely to
operate in Singapore. [3]

Similar to Command word: ‘Explain why’ [Pg 22]
Requirements: Elaborate on the reason(s) using economic analysis

A market is a group of firms producing same or similar products. Market structure
is defined by key characteristics. A market is classified according to its
characteristics which include number of firms, degree of freedom of entry and nature
of product. The characteristics of 5-star hotel industry in Singapore fit into oligopoly.
There are a few large dominant players which results in concentration of market
power in a few hands such as Conrad Centennial, Hotel Intercontinental, Hyatt,
Marriot, Pan Pacific. Each player’s market share is significant relative to the whole
market which leads to mutual interdependence esp. within the same locality for e.g.
among Pan Pacific, Marina Mandarin and Conrad Centennial in Marina, and among
Hyatt, Mandarin and Goodwood Park in Orchard. There is significant barriers to entry
in the form of an enormous capital outlay. There is significant internal economies of
scale and the LRAC falls over a large output, MES output is large in relation to size
of demand. Fixed cost a much larger proportion of total cost, compared to variable
cost as there is highly capital intensive and indivisible nature of fixed capital
investment There is likely to be large advertising spending which is a large overhead.
Diagram of falling LRAC spreading over a large output. Another BTE is these hotels
operate in a niche market where very strong brand loyalty forms a formidable barrier
to entry. Heterogeneous (differentiated) products are offered in the form of
differentiated hospitality and short-term accommodation services.
Explain and evaluate how the following strategies can help a firm to increase
its profits:

context
(a) Product development for monopolistic or oligopolistic firms
Companies in the telecommunications industry like Singtel or Starhub, may seek to

further distinguish their products from rivals via product development, whereby
Starhub is able to offer better quality services by upgrading their telecommunications
infrastructure. They are also able to do so as these large firms have accumulated
past supernormal profits to fund for such purposes.
[impact on firm’s demand] The demand for Starhub’s services would increase due
to a change in taste and preference (AR1 to AR2 in Figure 14(above part b)).
Demand will also become relatively less price elastic as product development seeks
to reduce the degree of substitutability.
[impact on firm’s profits] As such, this leads to an increase in the firm's profits (from
a situation of normal profits to a situation of supernormal profits of P2ABC at the new
profit maximising output level at Q2 where MC=MR2), assuming total costs remain
unchanged as shown in Figure 14. This makes product development an effective
strategy for Starhub.

[Explain how well non-price competition works]
However, product development tends to increase the costs of production for firms.
The effectiveness of this strategy would be dependent on the extent of increase in
cost relative to the increase in TR. Should TR increase less than the increase in TC,
this may reduce the effectiveness of the strategy as the extent of increase in
profits may be limited.
(b) Use of automation and technology to reduce costs
Large supermarket firms have been adopting the use of automation and technology
to reduce labour costs. For instance, the use of self-service paying kiosks would
create a more efficient method of payment. This reduces the need for as many
cashiers to scan and receive payments, which can be prone to human error. They
are also able to adopt such technology as these large firms have accumulated past
supernormal profits to fund for such purposes.
Therefore, this can help to reduce unit cost of production as the fall in variable costs
in the form of labour costs (wages) will lead to a fall in AC and MC (from AC1 to AC2
and MC1 to MC2 in figure 15 below), causing a rise in supernormal profits from
P1abc to P2def at the new profit maximizing output level Q2 (where MC2=MR).
Thus, this cost-reduction strategy is effective in raising the supermarket firm’s profits,
assuming TR remains constant.
Figure 15
[Explain how well it works] However, how effective this strategy is in reducing
cost and increasing profits depends on the proportion of total cost that is
contributed by labour costs (wages). If wages take up a large proportion of total
costs faced by the firm, then the strategy will be very effective in reducing total cost
to a greater extent, hence leading to larger increase in profits, ceteris paribus.


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Unit 3 Market Structure - Suggested Questions for H2 Economists (Week 10 – Term 4

Basic Questions for Market Structure

(a) Production & cost

1. Distinguish between fixed and variable costs. [6]

2. Using appropriate examples, distinguish between internal and external economies

3. Explain 2 sources of internal diseconomies of scale. [6]

(b) Objectives of firms

2. Evaluate if firms in reality practise this condition. [4]

3. Explain the meaning of sales revenue maximisation. [4]

4. Evaluate if sales volume maximisation will contribute to profit maximisation for

Tampines Meridian Junior College

1. Define a perfectly competitive industry [2]

2. Explain the key features of a perfectly competitive market. [5]

3. Explain 3 advantages and 3 disadvantages of a perfectly competitive market

1. Define a monopoly. [2]

2. Explain the key features of a monopoly. [5]

3. Explain what is meant by price discrimination. [2].

5. Explain the 3 advantages and 3 disadvantages of a monopolistic market structure.

7. Explain what a monopoly will do to preserve its supernormal profits. [5]

Tampines Meridian Junior College

1. Explain the meaning of five firm market concentration ratio. [2]

2 Define an oligopoly. [2]

3. Explain the key features of an oligopoly. [5]

4. Explain 3 advantages and 3 disadvantages of an oligopolistic market structure.

5. Explain how a cartel works. [4]

(f) Additional Questions on Market Structures

Firm Shape/Slope Diagram of the demand Explain the reasons

(a) Product development for monopolistic or oligopolistic firms

Tampines Meridian Junior College

a) Production & cost

1. Distinguish between fixed and variable costs. [6]

Reference to CSQ Skills Package:

2. Using appropriate examples, distinguish between internal and external

Reference to CSQ Skills Package:

Tampines Meridian Junior College

Internal economies of scale may be due to the following: technical, financial,

Tampines Meridian Junior College

Reference to CSQ Skills Package:

Tampines Meridian Junior College

Reference to CSQ Skills Package:

Internal diseconomies of scale are the cost disadvantages a firm experiences as it

High cost of monitoring and management

Reference to CSQ Skills Package:

External diseconomies of scale are the cost disadvantages a firm experiences as

Such diseconomies result primarily from the geographical concentration of firms in

Tampines Meridian Junior College

(b) Objectives of firms

Reference to CSQ Skills Package:

Explain profit maximizing condition:

Development: Explain the derivation of the Profit Maximizing Condition

Explain why profit-maximising output occurs when MC = MR.

Explain how the firm determines its profit maximizing price

Firms maximize their profits based on the marginalist principle.

2. Evaluate if firms in reality practise this condition. [4]

Reference to CSQ Skills Package:

[Evaluation 1: Lack of information & violation of ceteris paribus assumption]

3. Explain the meaning of sales revenue maximisation. [4]

Reference to CSQ Skills Package:

Tampines Meridian Junior College

4. Evaluate if sales volume maximisation will contribute to profit maximisation

Reference to CSQ Skills Package:

Firms choose a sales volume maximisation objective as they want to achieve a