09 Econs Mock ExamPost-Mortem

(a)(i)Compare the changes in the price of natural gas

and the changes in the price of electricity over the period between 1996 and the 2nd quarter of 2006. [2]

(a)(i)How many marks will you award the following answers?• “Both the price of electricity and natural gas increased

from 120.3 to 149.3 and 112.7 to 183.5 respectively between 1996 and 2nd quarter of 2006.”– Zero marks– 120.3 is a price index, not price

(a)(i)How many marks will you award the following

answers?• “Both the price of electricity and natural gas

increased from 120.3 pounds to 149.3 pounds and 112.7 pounds to 183.5 pounds respectively between 1996 and 2nd quarter of 2006.”– Zero marks– 120.3 is a price index, not price

(a)(i)What is a price index?• The base year price index is always 100• The base year is a year of reference, e.g. 1990=100• If the price index in 2006 is 149.3, then it means that the

price has increased by 49.3% between 2006 and 1990.• If the price index in 2006 is 60, it means that the price has

fallen by 40% between 2006 and 1990.• If the price index in 1996 is 112.7 and that in 2006 is

183.5, then between 1996 and 2006, prices have increased by 62.8%.

(a)(i)How many marks will you award the following

answers?• “Both the prices of natural gas and electricity

showed a downward trend from 1996 to 2001, but a upward trend from 2001 to the 2nd quarter of 2006. There was an overall 62.8% and 24.1% increase for natural gas and electricity respectively from 1996 to 2nd quarter of 2006.”– Max 1 mark– Only shows similarity, no obvious difference highlighted

(a)(i)

• Similarity [1 mark]– Prices of both natural gas and electricity have increased.

• Difference (however…) [1 mark]– Price of natural gas increased more than electricity.– 62.8% increase in price of natural gas compared to a

lower 24.1% increase in price of electricity. – Price of natural gas fell from 1996 to 2000 whereas that for

electricity fell for a longer time period from 1996 to 2001.– Etc.

NOTE: Must have “comparison” words

Do not just quote figures, INTERPRET them

Examiner’s report(a)(i)

•This question was generally well done, with most candidates able to make two valid points of comparison as instructed.

•A small number lost marks, however, because they described the changes in the price of each type of fuel chronologically

and as a result the points of comparison were not clear.

•In addition it was disappointing that a number of candidates did not fully understand the basis of index numbers. Some for example, stated that the price of natural gas was higher than the price of electricity in the later years. Others thought that

the prices were expressed in pounds sterling. More thorough understanding of the basis of indices and more care in reading and interpreting the data would result in more confident data

handling and fewer marks would be lost.

BAD

GOOD

(a)(ii)The change in price of which fuel in that period has had the greatest impact upon the cost of living? Explain your answer. [3]

(a)(ii)

• From table 1: In terms of extent of increase in price over time, price of “oil and other fuels” increased by the greatest extent.

• No marks awarded if student says “the weights for oil and other types of fuel increase by the greatest extent”

Oil and other types of fuel (max 1 mark only if explanation is correct)

(a)(ii)

• From table 2: In terms of weight, electricity is the most heavily weighted type of fuel.

Electricity (max 1 mark only if explanation is correct; 0 mark if explanation is incorrect)

(a)(ii)

• From table 2: In terms of weight, electricity is the most heavily weighted fuel. However natural gas is the next most heavily weighted index and has almost same weight as electricity. In addition, price of natural gas increased significantly more than electricity (62.8% compared to that of 24.1%) – 1 mark

• From table 1: In terms of extent of increase in price over time, price of “oil and other fuels” increased by the greatest extent followed by natural gas. However, weight of “oil and other fuels” is very low compared to natural gas– 1 mark

• Hence, change in price of natural gas has the greatest impact on cost of living given the combined influence of its weight and extent of increase in its price on cost of living

Natural Gas (max 3 marks if explanation is correct; 0 marks if explanation is incorrect)

(a)(ii)

This question brought a range of responses from candidates, some more successful than others. Careful examination of the data reveals that the change in the price of natural gas over the period is the highest of all the

types of fuel with the exception of the category, ‘Oil and Other Fuels’. Since natural gas has a much greater weight in the Retail Prices Index

however, it is clear that natural gas will have the greatest impact upon the cost of living. Many candidates were able to identify natural gas as the correct answer and justify this in clear terms. Some, however, did not consider the data as a whole and lost marks as a result. For example, some chose electricity, and explained that this was because it had the highest weight, ignoring the fact that the price change of electricity was much less than gas. Others chose oil and stated that they chose this

because it had the highest price change. They ignored the significance of the weights. Both these approaches gained some marks because they

clearly had some idea of the meaning of the cost of living, but marks were lost because the understanding was obviously incomplete.

(b)Explain an economic advantage that SSE might have

lost through its decision not to launch a takeover bid in Nov 2006. [2]

(b)• State the advantage lost (1 mark)• Explain the advantage lost (1 mark)

• Cost-/Supply-side: internal economies of scale which lowers the firm’s long run average cost due to a larger output as a result of the takeover assume constant revenue conditions, this will lead to increased profits

OR• Revenue-/Demand-side: increased market power seen

from larger market share, giving the bigger firm greater control over its price (more monopoly power), allowing it to earn greater profits (assume constant cost conditions)

(b)This question was done well by most candidates. Many stated that the decision not to take over Scottish Power meant that SSE would lose the benefits of economies of scale. Others suggested that without the takeover SSE would not benefit from the increased market share that would have been available. Identifying either of these

benefits of the takeover was sufficient for a single mark here. To gain both marks available, however, it was necessary to go on to explain the advantage of the

takeover. For example, it was necessary to explain that economies of scale would lead to lower average costs or that increased market share would allow the larger firm to

have greater control over prices and as a result lead to higher profits. Many candidates failed to go on to explain

the benefit and lost a mark as a result.

(c)Compare the supply curves of natural gas for the UK

in March 2006 and Oct 2006, and explain any changes that have occurred. [5]

(c)Compare the supply curves of natural gas for the UK in

March 2006 and Oct 2006, and explain any changes that have occurred. [5]

• Compare what– Position of supply curve

• Supply increase or decrease

– Shape of supply curve• More price elastic in supply or less

• CASE– Case evidence– Apply economics– Supplementary ideas– Explain and evaluate

(c)• Increase in supply: shift supply curve rightwards

– Case evidence (1m): “new pipeline from Norway” (extract 2)– Link to ecoping (1m): Due to increase in capital input,

producers are willing to increase the quantity supplied of gas at a given price, causing supply curve to shift to the right from Smar to Soct

• Increase in PES (2m): supply was relatively gentler in Oct 2006 compared to Mar 2006– There is an increase in PES of natural gas since there is

now one more pipeline and the capacity to produce gas would have increased. This increase in capacity (a factor affecting PES) will be quite underutilised and so the ability to increase quantity supplied in response to any increase in price will be greater

• Diagram (1m if explained and supply curve shifts outwards and also become more PES) Smar

Soct

Quantity of natural gas

P

(c)Between March and October 2006 it could be reasoned that the

supply of natural gas to the British market had increased because of the opening of a new pipeline from Norway. This would result in a shift in the supply curve for natural gas to the right. In addition it

could be argued that the new pipeline made it possible for the quantity of gas supplied to be more responsive to changes in

price, so that the supply curve had become more elastic. A large number of candidates gained marks for the explanation of the

supply curve shift and this was usually shown on a diagram. Far fewer made any comment about elasticity. It was also observed that a number of those who did make comment on the change in elasticity made no reference to the shift in the curve. Candidates

are advised that very often there are a number of economic effects that result from changing economic circumstances and the

identification of only one effect may well result in incomplete analysis.

(d)Discuss what might happen to the demand for electricity

as a result of the price changes identified in the case study. [8]

• Clarify “price changes”– Change in price of natural gas, a substitute in demand– Change in its own price

• Refinements to analysis (without which max 3m): CED and PED

• TAS

• CASE– Case evidence– Apply economics– Supplementary ideas– Explain and evaluate

(d)• Increase in demand for electricity (rightward shift of

demand curve for electricity)– Due to increase in price of natural gas [case evidence]– Consumers will switch to electricity as a cheaper fuel

substitute since price of natural gas is relatively higher– Extent of change in demand depends on CED [define]

between electricity and natural gas explain and justify sign and high and low CED values (e.g., price differentials)

• Fall in quantity demanded for electricity (movement along demand curve)– Due to increase in price of electricity [case evidence]– Quantity demanded will fall because of law of demand– Extent of change in quantity demanded depends on PED

[define] for electricity explain and justify sign and high and low PED values (e.g., contracts)

(d)• Thesis: Increase in demand for electricity

(rightward shift of demand curve for electricity) due to increase in price of substitutes

• Anti-thesis: Fall in quantity demanded for electricity (movement along demand curve) due to increase in price of electricity

• Synthesis: Overall demand for electricity may rise given that the price of natural gas increase more significantly than the price of electricity.

(d)

In response to this question, candidates needed to use the concepts of price and cross elasticity of demand to examine the impact of price

changes on the demand for electricity. Some good answers were provided here with many candidates showing a good grasp of the relevant concepts and the ability to apply these as required. Unfortunately, some candidates used only one concept to explain the impact, and lost marks as a result.

The question asked for the change in prices, so changes in both the price of electricity and changes in the price of the other fuels shown in the data were relevant. Omitting to mention either type of elasticity in the analysis meant that the explanation was considered incomplete. In addition, not all candidates provided evaluative comment here. Contained in the data were several factors that influenced the extent of the response of the demand for electricity as the price of electricity and the other fuels changed. For example, the fact that customers are on long-term contracts would mean

that it would be some time before they could switch to alternative types of fuel. In addition the cost of switching from one fuel to another might be

high. Such factors influence the responsiveness of demand for electricity to the price changes and provided scope for evaluative comment.

(e)Dicuss whether the market for fuel in the UK

displays economic efficiency or whether it provides an example of a market failure. [10]

• Clarify “economic efficiency” and “market failure”• TAS

• CASE– Case evidence– Apply economics– Supplementary ideas– Explain and evaluate

(e)

Introduction• Economic efficiency = allocative efficiency (define + condn)

+ productive efficiency (define + condns)• Market failure refers to inability of free market to achieve

– Efficiency (Allocative and/or Productive efficiency)– Equitable distribution of income

(e)Thesis: “economic efficiency in UK fuel market is theoretically supposed to

be improving”• Privatisation of energy market

– Greater focus on π-max– Reduces productive inefficiency as firms try to min TC to max π

• Deregulation of energy market– Lower the barrier to entry + increase contestability– Threat of potential entrants will reduce likelihood of incumbent firms pricing

too high and earning obscene amount of supernormal profits– Lower prices + larger output for consumers reduces allocative

inefficiency• Creation of regulatory bodies

– Office of Gas and Electricity Markets (Ofgem): aims to increase competition in the energy market reduce market power that individual energy firms may abuse reduce allocative inefficiency

– Energywatch: aims to represent the interest of consumers and increase the bargaining power of buyers limit the ability of energy firms to exploit consumers due to their monopoly power reduce allocative inefficiency

(e)Antithesis: “However, there are many examples of market failure in UK’s fuel

market in reality based on the case evidence”• Imperfect competition

– UK fuel market is oligopolistic [case evidence]– Allocative and Productive inefficiency – Oligopoly firms enjoy market power practice monopoly pricing – Price rigidity price & quantity does not respond to changing costs

• Immobility of factors to go where needed– UK energy market is operating in the midst of Europe’s tightly regulated energy

markets [case evidence]– Poor distribution of natural gas through Netherlands pipeline mentioned in Extract

1 meant that despite a shortage in UK and plentiful supply in the Netherlands, gas was not moving from the Netherlands to the UK [case evidence]

– This represents allocative inefficiency as natural gas is not reallocated to the higher bidding market

• Immobility of consumers to switch [case evidence]– Long-term contracts consumers cannot increasing quantity demanded of

natural gas in response to lower wholesale prices– Allocative inefficiency occurs consumers “under-consume” cheaper natural

gas

(e)Synthesis• Make a stand and justify how you arrive at that stand• Example:

In theory, economic efficiency in the UK fuel market was expected to improve due to UK’s privatisation and deregulation drive and the setting up of Ofgem and Energywatch. However, the case evidence shows that in reality, there remains many examples of economic inefficiency in the fuel market due to the relatively small number of energy firms in the market and the business strategies employed. Moreover, tightly regulated energy markets in other European countries hinder the attainment of economic efficiency in Europe’s energy market, including UK’s. Hence, the UK fuel market remains more of an example of market failure.

(e)In order to score well on this question, candidates needed a good grasp of the

concept of economic efficiency, together with the ability to apply the concept to the material in the case study.

Examination of the data shows that the intention of the UK government was to improve efficiency by deregulating the fuel market and in addition creating

regulatory bodies that would ensure that the interests of consumers were met. This would lead to more competition, which should in theory lead to lower prices and greater consumer choice. In fact the case study provides many

examples of inefficiency in the market for fuel. One example was the fact that resource allocation was not responding to price signals, as shown by the poor distribution of natural gas through the Netherlands pipeline, despite the higher

prices in the UK market. Another example was the large profits of the fuel companies. Most candidates had a good grasp of efficiency criteria and scored well. Some, however, proved unable to assess whether what would be expected in theory did occur in the case study and scored less well. In addition, there was

variation in the extent to which candidates gained credit for evaluation. Some candidates, for example, scored poorly because they failed to consider the data

as a whole and provide a balanced evaluative summary. This is an essential requirement for questions of this type, which carry a high mark allocation.

HOW MANY MORE DAYS TO PROMOS?

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