(2016) A Level H2 Econs Essay Q3 Suggested Answer by Mr Eugene Toh (A Level Economics Tutor)

(2016) A Level H2 Econs Paper 2 Essay Q3

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3. In Australia, small and remote communities face high and stable prices for petrol. The petrol is supplied by one or two small petrol stations owned by small independent retailers. Prices are lower and more volatile in the large cities, where there are a large number of big petrol stations owned by a small number of big oil companies.

Source: Australian Institute of Petroleum

(a) Explain why less market competition might lead to higher and more stable prices. [10]

Explain what it means by ‘less market competition’ and provide examples

  • Higher barriers to entry

  • Oligopolistic firm (less market competition) vs monopolistic competitive form (more market competition)

 

Why less market competition might lead to higher prices

  • Use characteristics of Oligopoly vs MC to do comparison

  • Oligopoly – few large firms

  • MC – many small firms

  • Goods more substitutable, differentiated in MC market structure and also more firms available to choose from, therefore demand is more price elastic

  • Draw 2 diagrams showing differences between MC vs Oligopoly in terms of PED of the demand curves

 

Why less market competition might lead to more stable prices

  1. Explain how less market competition such as in the case of oligopoly, may lead to price rigidity due to mutual interdependence

  2. If a firm increases price above P, other firms would not will follow

    • therefore, the firm will operate at the segment where demand is price elastic

    • there would be a more than proportionate fall in quantity demanded, and consequently a fall in total revenue

  3.  If a firm decreases price below P, other firms would follow suit and

    • therefore, the firm will operate at the segment where demand is price inelastic

    • there would be a less than proportionate increase in quantity demanded and consequently a fall in total revenue

(b) Assess whether differences in the level of competition are likely to be the main reason for differences in the retail prices of petrol in rural and urban areas of Australia. [15]

Differences in level of competition is likely to be one of the main reasons for differences in the retail prices of petrol in rural and urban areas of Australia

Due to less competition in rural areas, no close substitutes available, petrol retailers in rural areas are able to set higher prices as opposed to those in urban areas where significant competition is observed

 

There are other reasons that could explain differences in retail prices of petrol in rural and urban areas of Australia

Differences in size of firms

  • firms in urban areas produce at a higher output -> able to benefit from economies of scale -> pass on lower prices to consumers

 

Differences in demand

  • Higher demand for driving as opposed to public transport in rural areas due to lack of public transport (size of market)

 

Differences in supply

  • Higher cost of production in urban areas (due to higher rent, wages) -> lower supply

  • Higher taxes -> lower supply (this point is contrary to the difference in prices)

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