price theory 1

ECON1056 Price Theory Industry Analysis

Melbourne, Semester 2, 2019

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: Experts use specialist knowledge and skills to analyse the likely outcomes of different policy options. Experts then evaluate the policies against the government’s

objectives and statutory obligations.

• Communication: Experts must communicate their findings to ministers and senior public servants, who, in many instances, do not share the expert’s specialised knowl-

edge.

This assignment will assess your aptitude in both of these domains. You will analyse a

policy scenario detailed in section 2. Your Industry Analysis will form the basis for a policy

brief —a short report —summarising your recommendations and rationale.

The policy question is open-ended. This is extremely typical of the tasks you will

encounter in the workplace. The challenge is to approach an open-ended question in a

systematic and logical manner, drawing on your technical expertise as an economist.

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.

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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.

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2 Scenario

Lowlands Forest (”Lowlands”) is a an ecologically sensitive forest. For the last thirty years

the government has been carefully rehabilitating the forest, which provides rare habitat for

vulnerable species of flora and fauna. As part of the rehabilitation program, members of

the public have been banned from walking through the forest.

A recent ecological survey found that the forest is flourishing and many species have

returned. The Department of Environment and Natural Resources (DENR) has decided

to issue a single annual Ecological Tourism Licence, which will grant permission for a single

tourism operator to organise carefully-managed walking tours through Lowlands Forest.

The tourism operator will decide how many tickets to make available, and will be the sole

seller of tickets.

The department will charge an annual licence fee, which will generate government

revenue and help cover ongoing environmental protection and rehabilitation costs for Low-

lands.

There are two groups of people who would like to buy tickets for walking tours through

Lowlands: locals and tourists. The DENR is weighing up two different pricing policies:

• A “single-price policy”, in which all visitors are charged the same price for a ticket.

• A “two-price policy”, in which tourists and locals are charged different ticket prices.

The Local Bushwalkers’ Association (LBA) supports a two-price structure. The LBA

argues that many locals have chosen to live in the area because they appreciate the Low-

lands Forest, and they are worried that tourism will “crowd out” locals’ access to tickets.

The Tourism Association (TA) supports a single-price structure, because they feel that

tourists often get “ripped off” under a two-price structure.

2.1 Your task

You work for the Department of Environment and Natural Resources (DENR). The Min-

ister for the Environment is aware of the LBA and TA’s concerns, and wants you to:

• Evaluate the likely market outcomes under a single-price and a two-price policy (i.e. uniform pricing and price discrimination).

• Recommend whether the department should introduce a single-price policy or a two- price policy for the Ecological Tourism Licence.

• Recommend the price that the government should charge for the annual Ecological Tourism Licence fee.

You need to evaluate the policies and make your recommendations based on the minister’s

policy priorities. The minister’s office informs you that these priorities are:

1. To ensure that the Ecological Tourism Licence creates benefits for stakeholders; and

2. To use the annual Ecological Tourism Licence fee as a source of government revenue.

The relevant stakeholders are tourists, locals, and the tourism operator. Note that the

licencing policy prevents the government from imposing any other form of market regula-

tion, such as price caps.

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2.2 Estimated consumer demand

Tourists’ demand in the market is estimated to be,

QT (P) = 1500 −P

Locals’ demand in the market is estimated to be,

QL(P) = 4000 − 4P

where P represents the price of a ticket in dollars.

It is easy to identify locals, who can present proof-of-address to qualify for cheaper

tickets. There is no danger of re-sale between groups. It is estimated that it will cost the

tourism operator $20 to make each ticket available, and that there will be no fixed costs

apart from the annual Ecological Tourism Licence fee.

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3 The industry analysis

For your industry analysis you must complete each of the steps detailed below. When

completing the steps you must:

• Type all equations using the ‘Insert Equation’ function in Microsoft Word (or equiv- alent).

• Show all of your working.

• Include sufficient written description for the reader to follow your process. (Use the lecture notes and worked solutions in the study guide as an indication of the required

level of detail.)

• Use appropriate economic terminology, understandable by an expert economist.

Failure to follow these instructions will result in lost marks. There is no page limit for the

Industry Analysis.

3.1 Required steps

Steps 1 – 8 describe the equilibrium in the market under uniform pricing.

Step 1: Derive the combined demand function for the market.

(5 marks)

Step 2: Using the information provided in the scenario, derive the tourism operator’s total

cost function. Exclude the cost of the annual licence fee.

(2 marks)

Step 3: Assume that the profit-maximising price is above the “choke-price” for locals.

Find the profit-maximising quantity and price (Q and P). Is this price consistent with the

assumption?

(9 marks)

Step 4: Assume that the profit-maximising price is below the “choke-price” for locals.

Find the profit-maximising quantity and price (Q and P). Is this price consistent with the

assumption?

(9 marks)

Step 5: What is the level of producer surplus under uniform pricing?

(3 marks)

Step 6: How many tickets will be available to locals, and what is the level of local con-

sumer surplus (CSL)?

(3 marks)

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Step 7: How many tickets will be available to tourists, and what is the level of tourist

consumer surplus (CST )?

(3 marks)

Steps 8 – 10 describe market conditions under price discrimination.

Step 8: What is the profit-maximising quantity and price for the local market (QL and

PL)? What is the level of consumer surplus in the local market (CSL)?

(10 marks)

Step 9: What is the level of consumer surplus in the tourist market under price discrimi-

nation (CST )? Clearly reference any results or calculations from previous steps.

(3 marks)

Step 10: What is the level of producer surplus under price discrimination?

(3 marks)

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4 The brief

The purpose of the brief is to communicate your recommendations to the decision-maker

who commissioned your analysis. You need to make sure that your brief clearly:

• Refers to the relevant policy priorities.

• Uses the results from your lndustry Analysis to evaluate the proposed policies.

• Recommends a course of action for the minister, based on your evaluation.

Senior government officials are extremely busy, so you need to make sure you write

clearly and stay on-topic. Do not assume that the decision-maker knows anything about

the policy issue—your brief is the only information they have, and your goal is to make it

easy to understand the topic and your recommendation.

• The maximum length for your brief is 2 pages.

• Any content in excess of 2 pages will not be read or graded.

Remember that the brief is for a non-expert audience. You must avoid technical terminol-

ogy and state everything in ‘plain English’. For example:

• Terms such as consumer surplus, producer surplus, price discrimination and uniform pricing have little meaning outside of economics and should be avoided. (Note: This

is not a comprehensive list.)

• 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 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.

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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.

Prepared by: Your name here.

Core Message

Write an executive summary of the brief. Your core message should consist of three-

four sentences: a summary of the scenario; a summary of the key rationale for your

recommendations; a summary of your recommendations.

Maximum length 5 lines.

Hint: The reader should be able to understand the core message without referring to

the scenario or the rest of the brief. Provide specific information and avoid generalities.

Recommendations

a) Concisely state your principal recommendations.

b) Optional: State any additional recommendations on subsequent lines.

Hint: Each recommendation should be stated as a clear course of action for the gov-

ernment. Be precise and avoid ambiguous statements.

Do not : explain or justify your recommendations; describe the consequences of your

recommendations; state conditions or caveats for your recommendations.

Key Information

Begin your key information section with 1–2 paragraphs of background information: de-

scribe the policy context and the purpose of the brief. Outline your framework for com-

paring policies and developing recommendations.

Do not use these paragraphs to foreshadow or explain your recommendation(s).

Use the remainder of the key information section to present the rationale behind your

recommendations. You should highlight any trade-offs involved in your recommendations,

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.

Do not: use subheadings to introduce or explain broad concepts.

• 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).

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Hint: Incorporate all the information required to support your recommendations in

the key information section, regardless of whether or not the same information has been

included elsewhere in the brief.

Do not assert facts that are not supported by either the scenario or your industry

analysis.

Financial Implications

Briefly summarise any direct financial implications of your recommendation(s) (if any) for

the Government. Include precise dollar amounts derived from your analysis and the policy

context.

Hint: The financial implications section should provide the reader with easy access

to any financial cost and/or benefit of your recommendations to the government, e.g.

changes to government expenditure or revenue. This section must be included even if

there are no direct financial implications from your recommendation(s).

Begin your industry analysis on a new page following the brief.

Hint: Use the ‘Insert Page Break’ function in Microsoft Word to ensure the page break

displays correctly.

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5 Rubric

Criteria Ratings

Subject line Excellent (5 marks) Satisfactory (3 marks) Unsatisfactory (1 mark) Not present (0 marks)

The subject is brief and appropriately

descriptive.

The subject is overlong and/or insuf-

ficiently descriptive.

The subject is inappropriate for the

scenario addressed in the brief.

The subject line is absent.

Core message Excellent (5 marks) Satisfactory (3 marks) Unsatisfactory (1 mark) Not present (0 marks)

The core message succinctly and ac-

curately summarises the brief as re-

quired by the template. The language

used is appropriate for a brief. The

core message does not exceed 5 lines.

The core message partially sum-

marises the brief. There may be a

lack of clarity, omissions, and/or in-

accuracies. The core message does

not exceed 7 lines.

The core message does not effectively

summarise the brief and/or the core

message exceeds 7 lines in length.

The core message and/or the core

message section are absent.

Recommendations Excellent (5 marks) Satisfactory (3 marks) Unsatisfactory (1 mark) Not present (0 marks)

The recommendation(s) address the

requirements of the scenario. Each

recommendation is clearly and con-

cisely stated, and contains no extra-

neous information.

The recommendation(s) substantially

address the requirements of the sce-

nario. The recommendation(s) may

be lacking in clarity, and/or contain

some extraneous information.

The recommendation(s) are insuffi-

cient to address the requirements of

the scenario, and/or substantially de-

viate from the requirements of the

brief.

The recommendation(s) and/or the

recommendations section are absent.

Key information Excellent (20–25 marks) Satisfactory (13–19 marks) Unsatisfactory (1–12 marks) Not present (0 marks)

The key information begins by provid-

ing the context for the brief. Sub-

headings accurately summarise the

findings of the industry analysis, with

each finding explained in a subsequent

paragraph. The findings are logically

ordered and, taken together, justify

the recommendation(s). Any addi-

tional issues raised in the scenario

are also addressed. The key infor-

mation is presented clearly and con-

cisely, with few if any incidences of

non-technical language. All signifi-

cant assertions are supported by find-

ings in the industry analysis.

The key information provides the

context for the brief. The ratio-

nale for the recommendation(s) is

present and supported by the find-

ings of the industry analysis. Any

additional issues raised in the sce-

nario are addressed. The logic of

the argument justifying the recom-

mendation(s) may lack the appropri-

ate structure and/or omit a necessary

step. The key information may lack

clarity, include extraneous elements,

and/or use language inappropriate for

a brief.

The key information fails to support

the recommendation(s). The argu-

ments presented may contain signif-

icant assertions unsupported by the

industry analysis, significant logical

flaws, and/or substantially misrepre-

sent the findings of the analysis.

The key information section (or

equivalent) has not been included in

the brief.

Criteria Ratings

Financial implications Excellent (5 marks) Satisfactory (3 marks) Unsatisfactory (1 mark) Not present (0 marks)

The financial implications of the rec-

ommendation(s) to the government

have been correctly detailed. The ac-

companying explanation is brief, in-

formative, uses appropriate language,

and contains no extraneous elements.

The financial implications of the rec-

ommendation(s) to the government

have been detailed with few (if any)

inaccuracies. The accompanying ex-

planation may be overlong, lack clar-

ity, contain inaccuracies, or utilise

language inappropriate for a brief.

The financial implications of the rec-

ommendation(s) to the government,

and/or the accompanying explana-

tion, contain significant errors or

omissions.

The financial implications and/or fi-

nancial implications section are ab-

sent.

Structure Excellent (5 marks) Satisfactory (3 marks) Unsatisfactory (1 mark) Not present (0 marks)

All elements required by the template

are present and in the correct order.

The industry analysis has been placed

on a new page following the brief. No

required section has been relabelled,

and no additional sections have been

included in the brief.

There are a maximum of two devia-

tions from the template with respect

to the existence, labelling, and place-

ment of the required elements.

The brief deviates substantially from

the template with respect to the exis-

tence, labelling, and placement of the

required elements.

The document does not contain a

brief (or equivalent).

Industry analysis Excellent (40–50 marks) Satisfactory (25–39 marks) Unsatisfactory (0–24 marks)

Note: Marks for this crite-

rion will be awarded consis-

tent with the model solu-

tions. The descriptions for

this criterion are indicative

only.

The analysis follows the correct

methodology with few (if any) errors.

All (or almost all) required working

is present, and the steps taken are

clearly and succinctly explained. Eco-

nomic terminology is employed cor-

rectly throughout.

The analysis is generally consistent

with the correct methodology. The

working may contain several errors or

omissions, and the accompanying ex-

planation is generally sufficient to al-

low the reader to follow the process.

The analysis deviates substantially

from the requirements of the sce-

nario. See the grader’s comments for

more details.