Price Theory - Industry Analysis
ECON1056 Price Theory Industry Analysis Melbourne, Semester 1, 2020 1 Introduction Decision-makers in government rely on the advice of experts when formulating policy or discharging their statutory responsibilities. In this assignment you will take the role of an expert economist, employed by a government department. An expert economist’s role in the government decision-making process is two-fold: • Analysis: Economists use their specialist knowledge and skills to analyse the likely outcomes of policy alternatives. They then evaluate these outcomes against the government’s objectives and statutory obligations. • Communication: Economists communicate their findings to ministers and senior public servants, who, in many instances, do not share their specialised knowledge. This assignment will assess your aptitudes in both of these domains. You are to conduct an industry analysis based on the scenario detailed in section 2. Then use your analysis as the basis for a brief (a short report) summarising your recommendations and the associated rationale. 1.1 Formatting requirements Your assignment must be typed using Microsoft Word, or a similar word processor. Both parts of the assignment should be included in the same document with the brief placed before the industry analysis. The document should have a professional appearance, appro- priate to a government workplace. Format your assignment as follows: • Use A4 sized paper with all margins at least 2.5cm. • Body text to be 12pt and black. (There is no minimum line spacing.) • All pages to be numbered. • DO NOT include a cover sheet or table of contents. 1.2 Grading There are a total 100 marks available in this assignment (50 marks for the industry analysis and 50 marks for the brief), and the assignment contributes 40% of your grade for Price Theory. The marks allocated to each step of the industry analysis are detailed in section 3. The marking criteria for the brief can be found in the rubric detailed in section 5. 1 2 Scenario The island nation of Autarka is growing concerned over the amount of rubbish accumulating in the waters off its coastline. This pollution is harming marine life, damaging fish stocks, and washing up on tourist beaches. Research by the National University of Autarka has determined that a significant component of the solid waste is the single-use plastic bottles used by soft-drink manufacturers. Currently, soft drink manufacturers in Autarka pay a tax of $0.40 on each bottle of drink they sell. The revenue from the tax is used to fund the cleaning of roads and public spaces. The scientific community is lobbying the government to increase the tax to $1.00 a bottle. The scientists suggest that any additional revenue could be used to fund programs to remove rubbish from the coastal waters. There are two producers of soft drinks in Autarka: Bubbles PLC and CarbonCorp. The two companies do not face competition from imports as the cost of transporting soft drinks into Autarka is prohibitively high. Moreover, there are no cost effective alterna- tives to single use plastic containers. The two companies have made submissions to the government opposing the proposed tax increase, which they claim will harm consumers. 2.1 Your task The Minister for the Environment has instructed you to determine the likely impact of the proposed tax increase on the market for soft drinks, and to recommend whether or not the government should implement the proposed tax increase. Your recommendation should take into account • the impact on government revenues, • the impact on consumers, and • the impact on the environment. Note that competition policy prevents the government from imposing any other form of market regulation, including price controls. 2.2 Industry structure Research into the soft drink market indicates that the two firms compete by selecting quantities (Cournot competition). Soft drinks are regarded as a homogeneous good by consumers, and inverse demand in the market is estimated to be, P = 6− Q 100,000 , where P represents the price of a bottle of soft drink, and Q is the total number of bottles sold per year. At present soft drinks sell for $3.80 a bottle. Bubbles PLC produces 140,000 bottles per year, paying $56,000 in bottle tax. CarbonCorp produces 80,000 bottles and pays $32,000. It is estimated that it costs Bubbles PLC $2.00 per bottle of soft drink produced, while producing a bottle of soft drink cost CarbonCorp $2.60. The fixed costs of production can be neglected in this analysis. 2 3 Industry analysis For your industry analysis you must complete each of the steps detailed below. The required analysis draws on content covered in lectures 6–10 (primarily lecture 9). When completing the steps you must: • Type all equations using the ‘Insert Equation’ function (or equivalent). • Show all of your working. • Include sufficient written description for the reader to follow your process. (Use the worked solutions in the study guide as an indication of the required level of detail.) • Use appropriate economic terminology. Your audience for the industry analysis is other expert economists who may be required to review your work. There is no page limit for the Industry Analysis. 3.1 Required steps When completing the industry analysis you should assume that firms are engaged in Cournot Competition. Step 1: Using the information provided in the scenario, derive a total cost function for each soft drink producer for the case in which the government levies a tax of $1.00 per bottle. Use QB to denote the quantity produced by Bubbles PLC, and QC to denote the quantity produced by CarbonCorp. Note that a firm’s marginal cost will be the sum of its cost of producing a bottle, and the tax that it must pay to the government on each bottle sold. (5 marks) Step 2: Using the cost functions from step 1, derive a profit function for each firm. (10 marks) Step 3: Derive each firm’s best-response function. (15 marks) Step 4: Solve the best-response functions simultaneously to find the equilibrium quantities for each firm. (10 marks) Step 5: Find the equilibrium price and tax revenue. (10 marks) 3 4 The brief The purpose of the brief is to communicate your recommendations to the decision-maker who commissioned your analysis. You need to provide enough information for the decision- maker to understand your recommendations, and to reach a decision on the matter at hand. However, senior government officials are extremely busy, so you must be brief. • The maximum length for your brief is 2 pages. • Any content in excess of 2 pages will not be read or graded. When writing the brief remember that it is for a non-expert audience. You must avoid using specialised economic terminology and state everything in ‘plain English’. For example: • Terms such as consumer surplus, producer surplus, and deadweight loss, have lit- tle meaning outside of economics and should be avoided. (Note: This is not a comprehensive list.) • On the other hand, the significance of terms such as price, revenue, and profit, are generally well understood outside of economics. The brief should not include any equations or diagrams. Tables and dollar amounts may be included as appropriate. 4.1 Template You must compose your brief according to the template detailed on the following pages. Instructions for each required element of the brief are included within this template. These instructions are reflected in the requirements of the rubric detailed in section 5. Ensure that your brief includes each of the elements detailed in the template, and that you do not reorder, rename, or omit any of these elements. 4 Briefing for the (insert decision-maker’s title here) Subject: Include a brief but descriptive subject line. Maximum length 1 line. Hint: The subject is, in effect, the title of your brief. Compose the subject as you would the title of a report. Prepared by: Your name here. Core Message Write an executive summary of the brief. Your core message should consist of three sentences: The first sentence providing a summary of the scenario. The second sen- tence summarising the key rationale for your recommendation. And the third sentence summarising your recommendation(s). Maximum length 5 lines. Hint: The statements in the core message should stand on their own. Provide specific information and avoid generalities. The reader should be able to understand the core message without referring to the scenario or the rest of the brief. Recommendation Concisely state the principal recommendation that arises from your analysis. Hint: Your recommendation should be stated as a clear course of action for the gov- ernment to pursue. Be precise. Avoid generalities and ambiguous statements. DO NOT explain or seek to justify your recommendation in this section. DO NOT describe the consequences of your recommendation. DO NOT state conditions or caveats for your recommendation. Key Information Begin your key information section with a short (1–2 paragraph) outline of the context for the brief (as detailed in the scenario), the problem under consideration, and any additional issues raised. Hint: These 1–2 paragraphs should set the scene for the reader. They should provide the reader with sufficient background information to understand the purpose of the brief. DO NOT use these paragraphs to foreshadow, explain, or justify your recommendation(s). Use the remainder of the key information section to present the rationale behind your recommendation(s). You should highlight any trade-offs involved in your recommenda- tion(s), and address any additional issues raised in the scenario. Your rationale should be presented as follows: • Use subheadings to concisely state the key findings of your industry analysis. The maximum length for a subheading is 2 lines (1 line is preferable). • Write a short paragraph following each subheading to briefly explain the finding. Taken together, the findings stated in the subheadings should form a logical argument supporting your recommendation(s). Hint: Incorporate all information required to support your recommendation(s) in this section, regardless of whether or not the same information has been included elsewhere in 5 the brief. Each subheading should be written as a statement of fact. DO NOT include an explanation within a subheading, leave that for the following paragraph. DO NOT assert facts that are unsupported by either the scenario or your industry analysis. Financial Implications Briefly summarise the direct financial implications of your recommendation(s) (if any) for the Government. Include the precise dollar amounts that come out of your analysis. Hint: The financial implications section should provide the reader with easy access to the financial cost and/or benefit of your recommendations to the government. This section is not a substitute for stating the financial implications elsewhere in the brief. Specifically, if the financial implications form a part of the rationale for your recommendation(s), they will need to be included in both the key information section AND the financial implications section. DO NOT use this section to summarise other market outcomes (eg. profit and price). DO NOT use this section to present arguments in support of your recommenda- tion(s). This section must be included even if