Practice question

Posted by: Jiahui from TPJC
Subject: H2 Economics


2008 GCE ‘A’ Level Question 1

Developments in modern technology, such as faster broadband internet connections, portable DVD players, iPods and MP3 players, have had major impacts on the demand for and supply of recorded music and associated products.

Assess how the markets involved might be affected by these developments. [25]



Show to what extent (large/ small) and in what way (increase/ decrease in demand/ supply) markets (recorded music, associated products) might be affected by developments in modern technology.


INTRO
• Define DD & SS
• How market equilibrium is achieved, via the adjustment process ( can be shown either in introduction or latter part of the essay)

BODY
1. Identify markets
a. Main markets for recorded music
i. CD markets
ii. DVD markets
iii. Online Music Market

b. Market for Associated products
i. CD and DVD players
ii. MP3 Players – Creative Zen, iPods


2. Using Demand and Supply analysis to assess how the above markets might be affected by the developments in modern technology.

(a) Consider the Recorded Music Market
DD Factors
Recorded Music on CD and DVD
• Recorded music on CD and DVD as substitutes
• DVD- audio has the potential to replace CD because of the higher quality of the sound. Demand for CD fall while demand for DVD increase. However, it depends also on how much consumers care about the difference in sound quality as the difference can be fairly subtle.
Recorded music on DVD and online music that can purchased from online music store
• The improved storage capabilities of DVDs combined with improvement in modern technology for capturing live concerts of artists in digital format has increased the demand of such DVDs, as people as opposed to buying tickets to view a concert which might cause discomfort because of squeezing with other concert goers or poor accessibility of venue, can enjoy and view the same concert in the comfort of their own home at a lower cost via the purchasing of DVD
• However there might be a differing cross elasticity of demand for DVDs and Live concerts as different people might view them as either strong or weak substitutes, with factors such as the atmosphere, and time lag between the DVD and actual concert factors affecting the cross elasticity of demand between the two substitutes.
• Recorded music on DVD and online music that can be purchased from online music store as substitutes – the improvement in technology that leads to faster internet connection in the modern day setting has led to higher download speeds which make downloading recorded music a convenient and popular method of getting their music for those who are internet savvy. This will lead to an increase in demand for recorded music from the online music stores. The ability to download music from illegal avenues for people who are not adverse to risk will further contribute to the rising demand for online music. The rising demand for online music may lead to a fall in demand for recorded music on DVD if the products are considered close substitutes in the eyes of the consumers

SS Factors
• Better technology  lower COP  ↑ SS of recorded music be it online or in DVD or CD  SS curve shifts rightwards.

Considering both changes in demand and supply of recorded music
• Illustrate the shifts in both DD/SS on diagrams taking into account the factors and relative shifts in the DD and SS curves in the markets for recorded music on CD & DVD and online music.
• For example, DD for CD decreases while SS of CD increases => equilibrium price falls while equilibrium quantity unknown
• For example, DD for DVD or online music increases while SS of both increases => equilibrium quantity increases while equilibrium price unknown.
• Consider the overall market for recorded music – the demand for recorded music will increase as it becomes more readily available in different forms. The supply of recorded music will increase with the developments in modern technology. With increasing demand and supply, the equilibrium quantity will increase while the change in equilibrium price will depend on the extent of increase in demand and supply.


(b) Consider the Associated Product Market (Hardware market)
DD Factors
• With the increased in demand for recorded music, the complements of recorded music such as CD and DVD players, MP3 players and Multi-functional Handphones will increase as well. Without such devices, the music cannot be played forming a direct relationship between the two goods.
• With the onset of newer technology, newer and more functional music players have appeared in the market at a faster and more furious pace and also the quality of music being offered by the music players are improving. One such example is the larger storage capabilities of MP3 players without compromising the size of the players. The music players seem to be growing in storage capabilities yet also having a smaller size increasing its portability. This in turn increase the attractiveness these players to the current generation of people who demands compactness and performance of the devices they carry on hand. This will thus lead to an increase in demand for MP3 players in particular iPODs as it being the market leader. The rising demand for such MP3 players will cause demand for DVD players to fall as they being substitutes. In addition the increasing preference for online music will decrease not only demand for recorded music on CD and DVD but their complements, i.e. CD and DVD players too.
• Consider time lag - the introduction of any new recorded music players will tend to be charged at high prices, and if buyers expect prices of such players to fall in the future, then demand for older technology recorded music players may not fall excessively at least in the short run.

SS Factors
• Better technology  lower COP  ↑ SS of recorded music players, in particular those that are not only sleek in design but also advanced in performance  SS curve shifts rightwards.


Considering both changes in demand and supply of associated products
• Highlight in particular for MP3 players that the demand for MP3 players will continue to rise and its supply will also continue to increase. This will lead to increasing equilibrium quantity and its equilibrium price will depend on the extent of shift of both demand and supply curves.
• As for DVD players, it depends on the time period in consideration and the way the product will evolve and change to compete with existing substitutes
• Consider the associated product market as a whole
- On the overall market level, the demand for the associated products will still increase as the major driving force for the associated products is the derived demand for such products because of the increase in demand for recorded music because of the technological advancement which work to the benefit of both the markets.
- There are little or weak substitutes for music players, with maybe only the radio forming a credible threat albeit still a weak one. As the consumer of radio has little control over the exact music he wants to listen, it is pretty incomparable to music players.
- With the improvement of modern technology, it is not uncommon to see music players combining the capabilities of playing recorded music along with the radio component within the player, greatly enhancing the attractiveness of such players as it offers consumer a choice between either.
• The supply of the associated products will increase with improvement in technology and increasing number of sellers in the market
• The increasing demand and increasing supply of associated products will mean increasing equilibrium quantity and the equilibrium price unknown. With technology being more advanced, the increase in supply may outpace increase in demand leading to a fall in price.


(c) Other Evaluative Comments
• Evaluate: technology keeps changing, products change (e.g. no more Walkman) > the products may themselves disappear from the market!
• Technological factors and substitutes are not the only factors affecting these markets, there are other factors that are present that will affect the markets involved. For example: Government Legislation on piracy, illegal online music. A momentous effort from the government to crack down on illegal downloads might shift consumers back to purchasing DVD/CD instead of downloading music online, however it might not have a significant impact as there are avenues for legal downloads of music, aided by the increased in downloading speed which make downloading music even more easier. However people might not be risk averse and might choose to continue their illegal activities if they considered DVD/CD and online music shops as poor substitutes of their “free” illegal music.

CONCLUSION
• The analysis made above are done using a ceteris paribus assumption, whereas in the real world more than one factor changes at a certain point of time in this case we are taking into account the changes in DD and SS because of technology. This could thus lead to a different analysis done above on the effects of other factors are taken into account.
• With the onset of newer technology, it is beyond our analysis to conclude what will actually happen to the different markets present in the recorded music market and its associated products. As with the previous case of the cassettes and walkmans which was eventually phased out by the producers because of the CDs and CD players, the future could be very uncertain for the above mention markets. The penetration power of the recorded music and its associated products is evolving along with technological progress, thus making the future of different products even within the market as a whole uncertain.


Suggested Mark Scheme

Level 1
1 – 9

• Identification of Law of DD and SS
• Stating of equilibrium condition.
• Listing of markets affected, DD and SS factors that affect the market.

Level 2
LL2 - 10 – 11
HL2 - 12 - 14

• Inadequate/inaccurate explanation or explanation of factors affecting DD and SS with little reference to context, and the new equilibrium price and quantity exchanged,
• Low L2 if only one of the markets are identified and explained with reasonable details/examples.
• High L2 if both markets are identified and explained with reasonable details/examples supporting

Level 3
15 – 21
LL3 15 – 18
HL3 18 - 21

• Low L3 when students are able to bring in technology and how it affects the DD and SS factors in the determination of market equilibrium with little/weak explanation
• High L3 when students are able to bring in relevant and detailed examples of how technology can affect the DD and SS factors in the determination of market equilibrium.
• Well developed answers for the two markets involved, and well-thought out explanation of how the relative magnitude of the shifts in DD and SS resulting in a change from the original equilibrium
• A good and well argued out explanation on the final equilibrium price and output given the relative magnitude of shifts in the DD and SS curves.

E1
1 – 2
• Mainly unexplained judgments. Analysis is largely evaluative but lacking in comparison, providing an unconvincing conclusion.
E2
3 – 4 • Judgments based on analysis, providing a reasoned conclusion, on how the markets are affect not only by technological factors but also exogenous factors.

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