Section B: Short Case study (15 marks) (1hour)

a) Explain why Apple in 2005 might have been considered to be a monopoly in digital players
and digital downloads. [4]
Note: In your answers, you have to state the characteristic of a monopoly very explicitly
before elaborating with evidences.
Characteristics
of
a
monopoly
Single seller:
100% market share and the
firm is the industry

Evidences

Unique product due to high

barriers to entry:
No close substitutes when
firm charges a high price,
consumers cannot turn to
alternatives.

From para 1, Apple had a share of 63 per cent for its iPod in the US
market and in the world markets, it had an 83 per cent share for
legal digital downloads.
Clearly, Apple does not enjoy the theoretical monopoly. However, in
practice it enjoys monopoly power because it has a large proportion
of the market and the rest of the market is highly fragmented.
It is considered a near monopoly.
There are significant barriers of entry to both iPod and iTunes
market.
Para 2, Apple has devised a simple to use, iconic must-have product
which other manufacturers have to date found impossible to
replicate. With iTunes, it has a simple to use piece of software which
allows digital downloads only to iPods.

b) Using a monopoly diagram, explain how Apple succeeded increasing its profits ten-fold,
mainly through sales of iPods, between 2003 and 2005. [4]

Price/Revenue/
Cost($)
X MC

P1

AC
P0

C0
C1

MC

State
Elaborate with
economic analysis

Exemplify with
evidences from
Data

Q0

AR0
MR1

MR0

AR1

Q1

Output

Apple was able to increase its profits ten-fold because demand for its iPod product
increased enormously.
Apple did it by creating the iconic must-have in people and also worked with recording
companies for legal download. These increased the demand for iPods significantly.
This can be shown in the above diagram when AR and MR increase. Output increased
from Q0 to Q1, price increased from P0 to P1 and total revenue increased from 0P0AQ0 to
0P1XQ1. Total costs increased from 0C 0BQ0 to 0C1YQ1 and profits increased from
P0C0BA to P1C1YX.
In 2005, Apple sales were more than double those of 2003 but profit increased from
$1.3 billion in 2003 to $137 billion in 2005.

(c) Discuss whether Apples strategy of charging high prices for its iPod was in its best
long term interests. [6]
Yes
Perspective for evaluation: Best interests Increase profits
Thesis: Yes it is in its best interests
Apple can earn high revenue and
profits through charging high prices.
Elaborate
Demand for iPod is price-inelastic.
with
Hence by increasing price, quantity
economic
demanded
falls
less
than
analysis
proportionally, and total revenue
earned by Apple increases. Hence,
even by charging high prices, Apples
revenue
remains
high,
which
contributes to supernormal profits.
State

Exemplify
with
evidence
from Data
Elaborate
with
economic
analysis

Profit was $1.3 bn, a ten-fold increase

from $137 million in 2003.

Exemplify
with
evidence
from Data

Apple produced a stylish, easy to use

piece of hardware at just the right
time
in
terms
of
changing
technologies. It combined that with
easy to use software for downloading
music. Again, Apple was in the right
place and the right time.

Anti-thesis: No it may not be in its best interests

State
Apple may not be able to increase profits
through charging high prices.
Elaborate
The danger is that a competitor will bring
with
out a rival product which is easy to use as
economic
the iPod and is much lower in price; This
analysis
could lower the demand for iPod which in
turn reduces revenue of Apple.
With such close substitutes, there is a
possibility that other brands will leapfrog
iPod in terms of sales in digital players.
Demand for iPod may become less priceinelastic and charging higher prices may
lead to fall in revenue, which could reduce
the profits earned by Apple.

It also can set aside bigger budget for

advertisements
to
continue
to
strengthen its iconic must-have in
youngsters. This further maintains the
price inelasticity of demand for Apple
products, which ensures that high
revenue is earned through charging
high prices.
This supernormal monopoly profits
give Apple the funds to develop new
products. In the long term strategy
may be to bring out a series of new
products which, like the iPod, will gain
technological
superiority
in
its
segment of the market.
Exemplify
with evidence
from Data

2006 could be the year when a rival, like

Sony or Samsung, come up with a better
product

Stand
Apple has the first mover advantage in that it has already gained a huge market share and the iconic must-have
image of iPod is a strong barrier to entry and thus allows Apple to continue charging high price in the short-run. In
such a competitive market, Apple needs to constantly upgrade its product and reinforce its image by heavy
advertising (to defend their monopoly position) and this warrants to charge a high price to ensure it has the money
to pump into R&D and advertisement.
However, Apple must always be on a lookout for potential rivals and it might have to match the price cut of worthy
competitors to prevent a huge loss in revenue and thus profits.

Section C: Data Response question (N2004 Qn 1) (1 hour)

The Market for Sugar in the UK
(a) (i) Compare the EU price of sugar with the world price of sugar over the period
shown. [2]

With reference to Fig 1

Similarity: BOTH prices experienced a falling trend. [1]
Differences (1 of the 2):
The EU price is 2 - 3 times higher than the world price. [1]
OR
The EU price is much more stable compared to the world price which is much more volatile. [1]
Note: To gain full marks, must have 1 similarity and 1 difference. Cap at 1 mark for 2
differences. But there are instances when there is indeed no similarity, 2 differences will
be acceptable.
Students may think that it is a good idea to write there is fluctuation in the price over
the period as an answer for a trend question. Caution that real world data usually
involves fluctuations and not to single it out as a point to highlight. This case is an
exception as the contrast between the volatility and the relative stability is great.
(a)

(ii) Explain any differences that you have observed. [2]

EU price was a guaranteed price floor which is fixed and controlled and as a result more stable
[1]. The world price on the other hand was determined by the forces of supply and demand
which explains the huge fluctuations [1].
OR
The EU price is higher than world price because of the import quotas of sugar cane in the EU
that raised the cost of production and thus the price. [1] On the other hand, the subsidies given
to EU exports of sugar lowered the world price. [1]

(b) (i) Identifytwo characteristics of BSC that suggest that it has monopoly power. [2]
Any 2 of the following though 1st two points are preferred:
Characteristics of monopoly POWER
Large market share
High barrier to entry
Ability to carry out predatory practice

Evidence
Para 2: BSC is the sole processor of sugar beet and enjoys
a large market share of the market for refined white sugar.
Para 3: Imports of sugar cane which is needed by its key
competitor Tate Lyle are limited by quotas and that ensures
BSC faces little competition.
Para 4: Blocking the entry of another firm into the market.

Note:
Monopoly power is different from being a monopoly. Dominant firms in an
oligopoly are assumed to have a monopoly power also.
Possible misconceptions: the fact that BSC received a guaranteed price for its
sugar indicated monopoly power.
(b) (ii) Explainone possible way in which BSC may have prevented the entry of another
firm into the market. [2]
Suggest a method [1] & explain how it works in the context of the market for sugar described
in the text [1].

Control of raw material supplies e.g. ownership of sugar beet plantations through
backward integration. This will prevent rival firms from having access to essential input
or gaining cost advantage through purchase of raw material supplies at competitive
price. This is also known as vertical price squeezing, where a vertically integrated firm,
which controls the supply of an input, charges competitors a high price for that input so
that they cannot compete with it in selling the finished good i.e. refined white sugar.

Predatory pricing policy: By selling below cost to drive competitors from the market.
This is possible if BSC cross-subsidize prices in a competitive market, thereby driving
out competitors and establishing itself as a monopoly in that market. Cross-subsidize
refers to the use of profits in one market to subsidize prices in another.

Queries from students:

1) BSC cannot practise predatory pricing since there is a price floor and the graph also does not show a
huge drop in price.
Precisely! Charging a price lower than the price floor is illegal and thus BSC is found guilty.
The graph will not sure such a drop in price as it ever happened, it is only for a short period of time.
2) Is vertical integration illegal?
It is if the firm is trying to consolidate its monopoly position by controlling raw material to BLOCK ENTRY.
Being the sole processor of beet, it may not be via vertical integration, it can be through contractual agreement with
beet producers - 'evil alliance'.
All these may have violated anti-trust laws and thus BSC was found guilty.

(c)
E

With the aid of a diagram, explain the impact of BSC's monopoly power on producer
surplus and consumer surplus in the market for sugar. [4]
MCMonopoly = SSPC

Cost/Re
PM A
C

B
Price & Output comparison for a monopoly & a PC industry under
D
PPC

QM

QPC
X
0

In a perfectly competitive market, equilibrium will be achieved at output Q PC where P=MC

and there is allocative efficiency maximising consumers surplus as shown by area EBPPC.
The impact of BSC's monopoly power would result in equilibrium at profit maximizing level of
MC=MR at pt D, setting price higher at PM and lowering output to QM.
This results in a reduction of consumer surplus to a smaller area of EAP M and the loss of
consumer surplus of area PM ABPPC.
PM AC PPC,is translated as a gain to producer in the form of producer surplus. Producer
surplus changes from PpcBX to PmADX. [1]
However, there is a deadweight loss of area ABD as output [QPC - QM] is not produced.

Examiners comments:
Many candidates failed to identify the correct producer surplus.
Diagram is important for this question.
Producer surplus is not the same as total excess profit.

(d)

With the aid of a diagram, discuss what the impact would be on BSC's profits if free
trade were allowed in the European sugar market. [5]
Price/Revenue/Cost ($)
P0
A
MCAC
Note: The original is a 3m explain question.

P1X
C1Y
C0B

MR1
0

Q1Q0

MR0 AR1AR0

As a result of free trade in the

European sugar market, new firms
would enter the industry.
OutputA fall in demand will cause AR 0 and
MR0 to decrease to AR1 and MR1
respectively. These resulted in
lower output from Q0 to Q1, lower
price from P0 to P1 and unit cost
rises from C0 to C1. Supernormal
profit decreases from P0C0BA to
P1C1YX.

Will there still be supernormal profits? Or will there be normal profits? Or subnormal
profits?
It depends on how much the demand has fallen for BSC. Given that it is an incumbent firm and
consumers might have certain brand loyalty and assuming the price and quality difference is
minimal, demand will not fall drastically.
Queries from students:
1) Why cant demand for BSCs sugar increase with free trade since there will be a bigger market?
EUs price is higher than world price with opening up of the market to free trade, it is more likely that
consumers will turn to imports.
2) Another common question is that will cost change with free trade as BSC might be able to import
cheaper raw materials.
This is not quite possible as BSCs raw material comes from UK not the rest of the world unlike Tate & Lyle
where the cane sugar is imported.
Examiners comments:
Use the CORRECT diagram for explanation.
A large no. of candidates responded with a market SS and DD diagram. With an appropriate
explanation, this was a valid approach in explaining the process in terms of the impact upon
price and market share. This was insufficient to explain the impact on profits. The decline in
price of sugar is likely to lower revenue. But, to explain the impact on profits, it is necessary
to refer to costs, which could be shown on a monopoly firm diagram but will not appear on a
market SS and DD diagram.

L3
L2
L1

Elaborate (Extend to include analysis)

Good explanation and illustration with diagram on the impact on BSC's profits if
free trade were allowed in the European sugar market.
Consolidate (Add some details application)
Explained impact on BSC's profits with diagram with little reference to context.
Knowledge/Recognise (Description)
Explained impact on BSC's profits with diagram without profits area shown (no
cost curves) with no/little reference to context.

5-6
3-4
1-2

Reform of EU farm policy

(http://www.bbc.co.uk/news/world-europe-11216061)
- What is CAP, how much it costs, who benefits from it, what reforms are being planned
- Students may be interested to find out more given recent EU crisis
EU Sugar Subsidies
(http://news.bbc.co.uk/2/hi/business/4118448.stm)
- How much EUs sugar subsidies cost, what reforms were being planned

http://www.reformthecap.eu/
The Common Agricultural Policy (CAP)needs fundamental reform. Every year, 57
billion more than 40% of the EU budget are spent without creating significant
value for society.
Key Data on the CAP
2009 overall budget (European Agricultural Guarantee Fund): EUR 41,131 million
Policy

Objectives

Main Instruments

2009
Expenditure

Market
Interventions

Raise and stabilise

market prices

Intervention
buying;
export subsidies

3,410

Coupled
Subsidies

Increase production of
selected goods

Production
premia;
area payments

4,846

Direct Income
Support

Reward
historic
entitlements

Single Farm Payment;

Single Area Payment

31,295

farmers'
support

Source: Financial Report from the Commission to the European Parliament and the Council on the
European Agricultural Guarantee Fund 2009 Financial Year.
Export Subsidies ( milllion)

2008 Expenditure
Total

926

Cereals

10

Sugar and Isoglucose

501

Fruit and Vegetables

19

Products of the Wine-Growing Sector

15

Milk and Milk Products

29

Beef and Veal

33

Pigmeat, Eggs, Poultry and Beekeeping

201

Processed Agricultural Products

118

Source: European Commission, 2009. Annexes to the Commission Staff Working Document
Accompanying the 2nd Financial Report from the Commission to the European Parliament and the
Council on the European Agricultural Guarantee Fund - 2008 Financial Year: SEC(2009) 1368

Part II.

Subsidies per member state in 2013 ( million)

Member States

Direct Aids

Pillar 2

Sum

Austria

752

533

1285

Belgium

615

78

693

Denmark

1049

106

1155

Finland

571

289

859

France

8521

1279

9800

Germany

5853

1387

7240

Greece

2217

672

2888

Ireland

1341

352

1692

Italy

4370

1441

5811

Luxembourg

37

13

50

Netherlands

898

103

1001

Portugal

606

611

1217

Spain

5139

1284

6424

Sweden

771

267

4737

United Kingdom

3988

749

4737

EU-15

36727

9163

45890

Bulgaria

580

396

976

Cyprus

53

21

75

Czech Republic

909

424

1334

Estonia

101

113

214

Hungary

1319

585

1904

Latvia

146

151

298

Lithuania

380

254

634

Malta

11

16

Poland

3045

1851

4896

Romania

1264

1356

2620

Slovakia

388

320

708

Slovenia

114

113

257

EU-12

8336

5595

13930

Total

45062

14758

59821

CAP Reform in a Nutshell

The Problem

EU agricultural tariffs and subsidies distort the economy. European

agriculture is not aligned with its comparative advantage, but skewed in favor of
those products that receive disproportional protection. Worse, support to
agriculture acts like an invisible tax on the manufacturing and service sectors.

The CAP harms EU trade interests. It discredits the free-trade argument and
serves as a pretext for maintaining barriers to trade in agriculture, manufacturing
and services.

The CAP is socially unfair. Poor farmers benefit little from the CAP. 20% of
recipients reap roughly 80% of the direct income support. More generally, social
policies should be targeted at the poor and not at farmers or any other sector.

The CAP has a weak environmental record. Only a tiny fraction of its budget is
spent on efficient agri-environmental payments, while environmentally harmful
farming practices, such as drainage of wetlands, are still subsidized.

The CAP undermines global food security and the fight against poverty.
The EU subsidizes exports which disrupt production abroad. Furthermore,
investing in agricultural research and development, especially if adapted to
developing country needs, is much more effective than subsidizing European
farm income and production.

The CAP is a burden on European integration. It creates an image of a

bureaucratic, non-transparent, and ill-managed EU. It wastes resources that
could, if employed more wisely, convince European citizens of the benefits of
integration. It nurtures a culture of national egoism that stymies rational,
efficiency-oriented decision-making on EU expenditures and budget financing.

The Opportunity

There is a good chance that the CAP will be revolutionized after 2013 when a
new long-term EU budget comes into force. The economic crisis has left a
heavy burden on public budgets, strengthening the hand of finance ministers.

The ecological crisis requires substantial shifts from wasteful handouts to

programs that preserve the climate, biodiversity, soils, and water.

The long-term trend of increasing agricultural prices and incomes weakens the
case for income-supporting subsidies that do not promote the provision of public
goods.

The Solution

European money should only be spent on European public goods. If

agricultural policies do not have positive effects that spill across national borders,

they should be fully financed by the member states that are in a better position
than the EU to pursue local preferences with financial responsibility.

The focus of the CAP should be on environmental objectives, such as

biodiversity protection, climate change mitigation and responsible water
management.

Accordingly, the CAP budget should be significantly reduced. The first pillar
of the CAP should be progressively abolished and many policies under the
second pillar should be removed.

EU oversight of national farm policies should be strengthened to avoid

subsidy payments that distort competition or hurt the environment.