(2020) A Level H2 Econs Essay Q3 Suggested Answer by Mr Eugene Toh (A Level Economics Tutor)

(2020) A Level H2 Econs Paper 2 Essay Q3

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3. Expectations of quick service restaurants (QSRs) or fast food chains are changing. Innovation required to keep abreast of changing consumer taste and to maintain a competitive advantage in Singapore, a market known for its discernment of food. 

Adapted from Ray Chua, How McDonald’s keep winning over Singaporeans, 21 June 2016

(a) Explain how the market structure in which fast food chains operate is likely to influence how prices are determined. [10]

Likely market structure of fast food chains 

  1. Fast food chains are likely to operate in an oligopolistic market structure 

  2. Few large firms dominate the market e.g. Macdonalds, KFC, Burger King 

  3. There are high barriers to entry – economies of scale by existing firms, brand loyalty 

  4. Firms are mutually interdependent (they respond to each other in pricing) 

 

How the oligopolistic market structure is likely to influence how prices are determined 

  1. Due to the high barriers to entry (brand loyalty), there are likely to be few substitutes – demand will likely be rather price inelastic 

  2. Presence of economies of scale allows firms to offer menu items at relatively lower prices 

  3. Firms will produce based on individual firm’s profit maximization output. 

  4. Due to mutual interdependence, prices are likely to be rigid. 

(b) Discuss whether innovation is the best strategy for fast food chains seeking to increase their profits. [15]

Introduction 

  1. Fast food chains can increase profits either by increasing revenue and decreasing costs 

  2. To increase revenue, they can engage in price or non-price competition 

  3. Firms can also try to cut costs through achieving economies of scale or embark on cost-cutting measures (reducing staff count) 

 

Price competition is not an ideal strategy 

  1. Firms in an oligopolistic market structure are mutually interdependent 

  2. If one firm cuts prices, all other firms will follow suit – demand remains relatively price inelastic so a decrease in price leads to a less than proportionate increase in quantity demanded, leading to a fall in revenue 

  3. If one firm increase prices, no other firm will follow, causing the good to become very substitutable, demand becomes very price elastic so an increase in price leads to a more than proportionate decrease in quantity demanded, leading to a fall in revenue(optional to state) 

  4. It is thus not ideal to engage in price competition 

 

Innovation is one way of carrying out non-price competition 

  1. Carrying out innovation can result in 

  2. Increased product variety / quality 

  3. Reduced cost of production due to process innovation 

  4. Increased product variety and quality can lead to an increase in demand and thus an increase in revenue 

  5. Product innovation can result in a decrease in cost of production à increasing profitability 

  6. However innovation through R&D can be costly 

  7. Most fast food restaurants keep their menu simple to keep costs down (complicated menu leads to longer preparation time, requiring more staff and reducing efficiency) 

 

Other measures to reduce costs 

  1. Fast food restaurants can also undergo mergers and acquisitions 

Increasing the number of outlets can allow for reaping of economies of scales à lower unit cost can lead to increase profitability 

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