1stClassEconomics.com
Model
Answers
Unit
3
January
2010
9)
A)
What
does
the
information
provided
suggest
is
the
market
structure
of
the
airport
industry
in
London?
Explain
your
answer.
(4)
BAA
own
London’s
three
largest
airports
in
Heathrow,
Gatwick
and
Stansted
(extract
1)
(KAA
1
mark).
Because
BAA
is
a
dominant
firm
it
could
be
argued
that
it
is
a
monopoly,
it
has
at
least
25%
market
share
(KAA
2
marks).
Also,
the
Competition
Commission,
who
investigate
monopolies,
are
forcing
BAA
to
sell
an
airport
(extract
1),
further
indicating
it
is
a
monopoly
(KAA
1
mark).
*B)
Assess
the
case
for
increased
competition
in
the
airport
industry.
(14)
More
competition
means
there
will
be
more
firms
(KAA
1
mark).
A
benefit
to
airline
passengers
will
be
lower
ticket
prices.
More
firms
in
the
airline
industry
means
more
competition,
firms
must
compete
by
lowering
their
costs
and
ultimately
lowering
their
ticket
prices
to
attract
passengers
from
rivals.
Airlines
will
be
more
allocatively
efficient
(P=MC).
So
consumer
surplus
rises
(KAA
2
marks).
Additionally,
passengers
will
benefit
from
a
more
efficient
service.
Airlines
must
become
more
efficient
to
compete
which
should
mean
quicker
flights,
less
delays,
less
bags
lost
and
a
better
airline
experience
for
passengers
(KAA
2
marks).
Also,
the
government/economy
will
benefit
because
there
should
be
more
international
flights
to
and
from
London
so
exports
should
rise
(KAA
2
marks).
Although,
if
the
airline
industry
is
a
natural
monopoly
then
more
competition
means
a
wasteful
duplication
of
resources.
More
airports
may
need
to
be
built
for
more
airlines.
This
is
very
costly
and
may
cause
resources
to
be
diverted
from
more
beneficial
uses
(E
2
marks).
Moreover,
more
firms
means
less
profits
and
thus
less
incentives
for
airlines
to
invest.
This
will
cause
inefficiencies
such
as
delayed
flights
in
the
future
(E
2
marks).
Furthermore,
more
competition
means
more
rivals
so
airlines
must
spend
more
on
advertising.
This
could
drive
up
airline
firms’
costs
and
cause
some
airlines
to
make
a
loss
and
go
bust
(E
1
mark).
Finally,
after
more
competition
has
entered
the
airline
market
it
may
become
an
oligopoly
and
thus
have
the
potential
for
collusion
and
high
prices.
So
consumer
surplus
may
fall
(E
2
marks).
C)
Discuss
the
effectiveness
of
the
Competition
Commission
in
regulating
industries
such
as
the
airport
industry.
(8)
The
Competition
Commission
(CC)
investigates
monopolies
suspected
of
abusing
their
market
power
and
potential
mergers
that
will
result
in
a
monopoly.
Any
merger
that
results
in
the
firm
owning
at
least
25%
of
the
market
can
be
blocked
by
the
CC.
The
CC
may
allow
a
merger
even
if
it
results
in
a
firm
becoming
a
monopoly
so
long
as
the
monopoly
acts
in
the
interest
of
the
consumer
by,
for
example,
investing
in
R&D
(KAA
2
marks).
The
CC
could
force
a
firm
to
sell
some
assets
as
it
did
in
the
airline
industry
by
forcing
BAA
to
sell
Gatwick
airport
(extract
1)
(KAA
2
marks).
However,
regulatory
capture
could
reduce
the
effectiveness
of
the
CC.
Regulatory
capture
occurs
when
a
regulator
makes
decisions
that
benefit
the
regulated
firm
instead
of
consumers.
Regulatory
capture
could
occur
if
the
CC
believes
inaccurate
information
given
to
them
by
BAA
(E
2
marks).
Also,
time
delays
may
cause
the
CC
to
be
ineffective.
The
airline
industry
regulator
must
first
pass
on
the
case
to
the
CC
who,
in
turn,
must
then
investigate.
The
longer
this
takes,
the
less
effective
the
CC’s
powers
will
be
(E
2
marks).
,1stClassEconomics.com
*D)
BAA
charge
more
for
landings
at
Heathrow
than
at
other
airports.
Evaluate
the
reasons
for
and
consequences
of
such
a
policy.
(14)
BAA
may
be
doing
this
because
it
has
monopoly
power
to
raise
prices
for
some
particular
services
to
earn
higher
profits
(KAA
2
marks).
BAA
are
basically
price
discriminating.
Price
discrimination
occurs
when
a
firm
charges
different
prices
to
different
consumers
for
the
same
good.
Landing
at
Heathrow
is,
essentially,
the
same
service
as
landing
at
other
London
airports.
Because
airlines’
demand
for
landing
at
Heathrow
is
more
price
inelastic
than
demand
for
landing
at
other
airports,
BAA
can
charge
airlines
a
higher
price
for
landing
at
Heathrow
(KAA
2
marks).
A
high
price
P’
is
charged
to
those
with
an
inelastic
demand
and
a
low
price
P’’
is
charged
to
those
with
an
elastic
demand.
Both
market
segments
earn
BAA
super-‐normal
profit.
As
long
as
the
red
and
green
super-‐normal
profits
sum
up
to
more
than
the
blue
super-‐normal
profit,
BAA
earns
more
profit
than
charging
a
single
price
P*
(KAA
2
marks).
Another
consequence
is
that
consumer
surplus
will
fall
because
those
with
an
inelastic
demand
are
charged
a
higher
price
than
before
(KAA
2
marks).
However,
because
landing
at
Heathrow
is
not
exactly
the
same
as
landing
at
other
airports,
this
is
not
technically
price
discrimination
but
product
differentiation.
BAA
are
likely,
and
within
their
rights,
to
charge
different
prices
for
these
different
services
(E
2
marks).
If
BAA
are
earning
extremely
high
super-‐normal
profits
by
charging
airlines
these
different
prices
then
the
Competition
Commission
may
investigate
them
as
they
are
potentially
acting
against
public
interests
(E
2
marks).
A
more
important
impact
on
the
costs
of
airlines
may
be
fuel
or
wage
costs
rather
than
what
airlines
pay
BAA
to
use
airports
(E
2
marks).
In
the
long-‐run,
if
more
competition
enters
the
market
then
BAA
may
not
be
able
to
do
this
any
longer
(E
1
mark).
, 1stClassEconomics.com
10)
A)
What
does
the
information
provided
suggest
is
the
market
structure
of
the
pharmaceutical
industry?
Explain
your
answer.
(4)
It
could
be
argued
that
the
pharmaceutical
industry
is
an
oligopoly,
that
is,
there
are
a
few
large
dominant
firms,
interdependency
and
high
entry
barriers
(KAA
2
marks).
The
pharmaceutical
industry
is
dominated
by
large
firms
such
as
Roche,
Pfizer,
Novartis
and
Merck
(figure
1)
(KAA
2
marks).
*B)
Discuss
the
benefits
that
Merck
might
expect
to
gain
through
the
takeover
of
Schering-‐Plough.
(12)
A
first
benefit
to
Merck
is
an
increase
in
market
share.
A
takeover
of
Schering-‐Plough
means
less
competition,
higher
market
share,
more
market
power
and
thus
the
ability
to
set
higher
prices
and
earn
higher
profits
(KAA
2
marks).
A
second
benefit
to
Merck
is
economies
of
scale.
A
firm
experiences
economies
of
scale
if
its
long-‐run
average
costs
fall
as
output
rises.
A
takeover
will
mean
Merck
can
benefit
from
financial
economies,
it
will
be
a
larger
firm
so
it
is
deemed
less
risky
by
creditors
and
can
obtain
larger
loans
at
lower
interest
rates
(KAA
2
marks).
A
third
benefit
to
Merck
is
that
it
will
break
into
new
markets
and
thus
diversify
and
reduce
risk.
Merck’s
sales
outside
of
the
US
will
increase
because
70%
of
Schering-‐Plough’s
revenue
comes
from
outside
of
America
(extract
1)
(KAA
2
marks).
However,
Merck
may
suffer
from
diseconomies
of
scale.
A
firm
experiences
diseconomies
of
scale
if
its
long-‐run
average
costs
rise
as
output
rises.
The
takeover
may
result
in
managerial
diseconomies
if
Merck’s
managers
take
on
too
many
responsibilities
running
the
larger
firm
(E
2
marks).
Also,
the
takeover
may
result
in
an
investigation
by
the
Federal
Trade
Commission.
The
larger
firm
may
exploit
its
increased
market
power
to
raise
prices,
this
is
not
in
the
public’s
interests
and
thus
the
takeover
may
be
blocked
(E
2
marks).
Furthermore,
the
takeover
may
not
succeed
Merck
have
preferred
to
grow
internally
by
making
new
products
in
their
own
laboratories
(extract
1)
(E
2
marks).
C)
Evaluate
one
pricing
and
one
non-‐pricing
strategy
that
Merck
could
adopt
to
increase
sales.
(12)
A
pricing
strategy
Merck
could
use
is
sales
maximization.
Merck
maximizes
sales
at
!" = !".
At
!" = !"
Merck
sells
all
the
output
it
can
without
making
a
loss.
Merck
earns
normal
profit
only
(KAA
3
marks).
Model
Answers
Unit
3
January
2010
9)
A)
What
does
the
information
provided
suggest
is
the
market
structure
of
the
airport
industry
in
London?
Explain
your
answer.
(4)
BAA
own
London’s
three
largest
airports
in
Heathrow,
Gatwick
and
Stansted
(extract
1)
(KAA
1
mark).
Because
BAA
is
a
dominant
firm
it
could
be
argued
that
it
is
a
monopoly,
it
has
at
least
25%
market
share
(KAA
2
marks).
Also,
the
Competition
Commission,
who
investigate
monopolies,
are
forcing
BAA
to
sell
an
airport
(extract
1),
further
indicating
it
is
a
monopoly
(KAA
1
mark).
*B)
Assess
the
case
for
increased
competition
in
the
airport
industry.
(14)
More
competition
means
there
will
be
more
firms
(KAA
1
mark).
A
benefit
to
airline
passengers
will
be
lower
ticket
prices.
More
firms
in
the
airline
industry
means
more
competition,
firms
must
compete
by
lowering
their
costs
and
ultimately
lowering
their
ticket
prices
to
attract
passengers
from
rivals.
Airlines
will
be
more
allocatively
efficient
(P=MC).
So
consumer
surplus
rises
(KAA
2
marks).
Additionally,
passengers
will
benefit
from
a
more
efficient
service.
Airlines
must
become
more
efficient
to
compete
which
should
mean
quicker
flights,
less
delays,
less
bags
lost
and
a
better
airline
experience
for
passengers
(KAA
2
marks).
Also,
the
government/economy
will
benefit
because
there
should
be
more
international
flights
to
and
from
London
so
exports
should
rise
(KAA
2
marks).
Although,
if
the
airline
industry
is
a
natural
monopoly
then
more
competition
means
a
wasteful
duplication
of
resources.
More
airports
may
need
to
be
built
for
more
airlines.
This
is
very
costly
and
may
cause
resources
to
be
diverted
from
more
beneficial
uses
(E
2
marks).
Moreover,
more
firms
means
less
profits
and
thus
less
incentives
for
airlines
to
invest.
This
will
cause
inefficiencies
such
as
delayed
flights
in
the
future
(E
2
marks).
Furthermore,
more
competition
means
more
rivals
so
airlines
must
spend
more
on
advertising.
This
could
drive
up
airline
firms’
costs
and
cause
some
airlines
to
make
a
loss
and
go
bust
(E
1
mark).
Finally,
after
more
competition
has
entered
the
airline
market
it
may
become
an
oligopoly
and
thus
have
the
potential
for
collusion
and
high
prices.
So
consumer
surplus
may
fall
(E
2
marks).
C)
Discuss
the
effectiveness
of
the
Competition
Commission
in
regulating
industries
such
as
the
airport
industry.
(8)
The
Competition
Commission
(CC)
investigates
monopolies
suspected
of
abusing
their
market
power
and
potential
mergers
that
will
result
in
a
monopoly.
Any
merger
that
results
in
the
firm
owning
at
least
25%
of
the
market
can
be
blocked
by
the
CC.
The
CC
may
allow
a
merger
even
if
it
results
in
a
firm
becoming
a
monopoly
so
long
as
the
monopoly
acts
in
the
interest
of
the
consumer
by,
for
example,
investing
in
R&D
(KAA
2
marks).
The
CC
could
force
a
firm
to
sell
some
assets
as
it
did
in
the
airline
industry
by
forcing
BAA
to
sell
Gatwick
airport
(extract
1)
(KAA
2
marks).
However,
regulatory
capture
could
reduce
the
effectiveness
of
the
CC.
Regulatory
capture
occurs
when
a
regulator
makes
decisions
that
benefit
the
regulated
firm
instead
of
consumers.
Regulatory
capture
could
occur
if
the
CC
believes
inaccurate
information
given
to
them
by
BAA
(E
2
marks).
Also,
time
delays
may
cause
the
CC
to
be
ineffective.
The
airline
industry
regulator
must
first
pass
on
the
case
to
the
CC
who,
in
turn,
must
then
investigate.
The
longer
this
takes,
the
less
effective
the
CC’s
powers
will
be
(E
2
marks).
,1stClassEconomics.com
*D)
BAA
charge
more
for
landings
at
Heathrow
than
at
other
airports.
Evaluate
the
reasons
for
and
consequences
of
such
a
policy.
(14)
BAA
may
be
doing
this
because
it
has
monopoly
power
to
raise
prices
for
some
particular
services
to
earn
higher
profits
(KAA
2
marks).
BAA
are
basically
price
discriminating.
Price
discrimination
occurs
when
a
firm
charges
different
prices
to
different
consumers
for
the
same
good.
Landing
at
Heathrow
is,
essentially,
the
same
service
as
landing
at
other
London
airports.
Because
airlines’
demand
for
landing
at
Heathrow
is
more
price
inelastic
than
demand
for
landing
at
other
airports,
BAA
can
charge
airlines
a
higher
price
for
landing
at
Heathrow
(KAA
2
marks).
A
high
price
P’
is
charged
to
those
with
an
inelastic
demand
and
a
low
price
P’’
is
charged
to
those
with
an
elastic
demand.
Both
market
segments
earn
BAA
super-‐normal
profit.
As
long
as
the
red
and
green
super-‐normal
profits
sum
up
to
more
than
the
blue
super-‐normal
profit,
BAA
earns
more
profit
than
charging
a
single
price
P*
(KAA
2
marks).
Another
consequence
is
that
consumer
surplus
will
fall
because
those
with
an
inelastic
demand
are
charged
a
higher
price
than
before
(KAA
2
marks).
However,
because
landing
at
Heathrow
is
not
exactly
the
same
as
landing
at
other
airports,
this
is
not
technically
price
discrimination
but
product
differentiation.
BAA
are
likely,
and
within
their
rights,
to
charge
different
prices
for
these
different
services
(E
2
marks).
If
BAA
are
earning
extremely
high
super-‐normal
profits
by
charging
airlines
these
different
prices
then
the
Competition
Commission
may
investigate
them
as
they
are
potentially
acting
against
public
interests
(E
2
marks).
A
more
important
impact
on
the
costs
of
airlines
may
be
fuel
or
wage
costs
rather
than
what
airlines
pay
BAA
to
use
airports
(E
2
marks).
In
the
long-‐run,
if
more
competition
enters
the
market
then
BAA
may
not
be
able
to
do
this
any
longer
(E
1
mark).
, 1stClassEconomics.com
10)
A)
What
does
the
information
provided
suggest
is
the
market
structure
of
the
pharmaceutical
industry?
Explain
your
answer.
(4)
It
could
be
argued
that
the
pharmaceutical
industry
is
an
oligopoly,
that
is,
there
are
a
few
large
dominant
firms,
interdependency
and
high
entry
barriers
(KAA
2
marks).
The
pharmaceutical
industry
is
dominated
by
large
firms
such
as
Roche,
Pfizer,
Novartis
and
Merck
(figure
1)
(KAA
2
marks).
*B)
Discuss
the
benefits
that
Merck
might
expect
to
gain
through
the
takeover
of
Schering-‐Plough.
(12)
A
first
benefit
to
Merck
is
an
increase
in
market
share.
A
takeover
of
Schering-‐Plough
means
less
competition,
higher
market
share,
more
market
power
and
thus
the
ability
to
set
higher
prices
and
earn
higher
profits
(KAA
2
marks).
A
second
benefit
to
Merck
is
economies
of
scale.
A
firm
experiences
economies
of
scale
if
its
long-‐run
average
costs
fall
as
output
rises.
A
takeover
will
mean
Merck
can
benefit
from
financial
economies,
it
will
be
a
larger
firm
so
it
is
deemed
less
risky
by
creditors
and
can
obtain
larger
loans
at
lower
interest
rates
(KAA
2
marks).
A
third
benefit
to
Merck
is
that
it
will
break
into
new
markets
and
thus
diversify
and
reduce
risk.
Merck’s
sales
outside
of
the
US
will
increase
because
70%
of
Schering-‐Plough’s
revenue
comes
from
outside
of
America
(extract
1)
(KAA
2
marks).
However,
Merck
may
suffer
from
diseconomies
of
scale.
A
firm
experiences
diseconomies
of
scale
if
its
long-‐run
average
costs
rise
as
output
rises.
The
takeover
may
result
in
managerial
diseconomies
if
Merck’s
managers
take
on
too
many
responsibilities
running
the
larger
firm
(E
2
marks).
Also,
the
takeover
may
result
in
an
investigation
by
the
Federal
Trade
Commission.
The
larger
firm
may
exploit
its
increased
market
power
to
raise
prices,
this
is
not
in
the
public’s
interests
and
thus
the
takeover
may
be
blocked
(E
2
marks).
Furthermore,
the
takeover
may
not
succeed
Merck
have
preferred
to
grow
internally
by
making
new
products
in
their
own
laboratories
(extract
1)
(E
2
marks).
C)
Evaluate
one
pricing
and
one
non-‐pricing
strategy
that
Merck
could
adopt
to
increase
sales.
(12)
A
pricing
strategy
Merck
could
use
is
sales
maximization.
Merck
maximizes
sales
at
!" = !".
At
!" = !"
Merck
sells
all
the
output
it
can
without
making
a
loss.
Merck
earns
normal
profit
only
(KAA
3
marks).
